July 28—No, it isn’t your imagination. Prices are up—consumer goods are over 5% higher than a year ago. Inflation is rising, too—and not just because of supply snafus and increasing demand due to COVID reopening. So, is it a temporary blip or will it be That ‘80s Show all over again? To discuss the prospect of inflation, and the Fed’s role in not letting it get out of hand, Chief Investment Officer Tony Roth welcomes former Fed economist Claudia Sahm, a senior fellow at Manhattan-based think tank, the Jain Family Institute.

Claudia Sahm.jpg

Claudia Sahm, Senior Fellow, Jain Family Institute, former Federal Reserve economist

Please listen to important disclosures at the end of the podcast

Wilmington Trust’s Capital Considerations with Tony Roth

Episode 38: Inflation—Fleeting or Here to Stay?
Tony Roth, Chief Investment Officer, Wilmington Trust Investment Advisors, Inc.
Claudia Sahm, Senior Fellow, Jain Family Institute, Former Federal Reserve economist

CLAUDIA SAHM: Us feeling like we’re getting the vaccines and getting out, like that’s part of the push that got inflation up. We feel safer going out. We’re making up for vacations, seeing family we didn’t last year. So, COVID pushed up this demand and everybody was going out at the same time. That’s going to dissipate, right. Less demand, the same amount of supply, well prices go down, right, or at least they stop increasing at such a high pace. COVID gave a push. That push isn’t going to keep happening. We can only reopen once.

TONY ROTH: That was Claudia Sahm, a senior fellow at the Jain Family Institute and contributing writer for Bloomberg. Claudia’s joining me to share her thoughts on inflationary concerns and possible Fed actions.

Welcome to Capital Considerations, the market and economic podcast that’s fully invested in your success. I’m your host, Tony Roth, chief investment officer of Wilmington Trust.
Inflation, it is without question the most important determinant of the economic cycle. Most economic expansions come to an end when the Federal Reserve feels the need to raise rates to cool inflation and in doing so sends the economy into recession. So, there are few indicators that are as important in forecasting economies and markets as are inflation expectations.

Today, however, there is perhaps more confusion and uncertainty around the inflation outlook than we’ve ever experienced. To help us digest recent events and data and lend insight into what the future may hold, we’re joined by Claudia Sahm.

Claudia was an Economist at the Federal Reserve Board from 2007 through 2019, where she was a section chief in the Division of Consumer and Community Affairs overseeing the survey of household economics and decision making. She was also senior economist at the Council of Economic Affairs under the Obama administration. Claudia is currently a senior fellow at the Jain Family Institute and a contributing writer for the New York Times and Bloomberg. Claudia, thank you so much for joining us today.

CLAUDIA SAHM: Thank you for having me.

TONY ROTH: Claudia, let’s start off with the idea of transitory. This seems to be the word of the moment and it’s all about inflation. The financial world is debating is the recent spike that we’ve seen in inflation data temporary or is it here to last. What do you think, Claudia? Is inflation transitory right now, this big spike, or is it going to dissipate pretty quickly?

CLAUDIA SAHM: So, I do think that what we are seeing, the pace of price increases, the level of inflation, I think that is temporary. Now, temporary is a very fuzzy word. It is not an accident that the Federal Reserve is using a word like that. And yet, as someone who worked for over a decade on the staff’s macroeconomic forecast at the Federal Reserve, more precision than that simply would not be warranted. We just—we don’t know yet.

I think it’s temporary. I think that’s the case when you look at the factors behind it, which I’m sure we’ll talk more about. But I would be lying and anybody else would if they said we know it’s temporary or we know it’s permanent. we really don’t know yet.

TONY ROTH: We’re going to look into the considerations that are going to help determine whether or not it’s temporary or to what degree it may be temporary. Let’s take a little bit of time and look back over the last decade, because the last decade has been really quite unusual in that we came out of the great financial crisis and since that time we’ve not really been able to get inflation back to the Fed’s target of 2% on any sustained basis.

They use PCE, which stands for personal consumption expenditure, which essentially denotes the level of price increases that are occurring broadly across the economy. But that’s just not been high enough. So, could you give us a bit of an overview, Claudia, of what’s happened over the last decade, just so we level set as we come out of the pandemic, why it is that the last decade has been so unusual from an inflation standpoint?

CLAUDIA SAHM: So, I started at the Federal Reserve in the summer of 2007 as a forecaster on the lead for consumer spending. And so, this start of the decade, the great recession/financial crisis, this will forever be burned in my brain as to what happened and how much the U.S. economy changed. And you are correct that as we came out of the financial crisis, the depths of the great recession, and we moved into a recovery, it was a very slow recovery.

We had a mortgage debt market that had really gone way past where it should’ve been. We had high unemployment, long-term unemployment. It really took a while to get things going again. What we saw is, year after year the pace of the recovery just wasn’t there like it should’ve been and this inflation never reached the 2% target.

I really don’t think the Fed messages well. Why do we want 2%? Why don’t we want zero? Like what is this about we want inflation? And I think the right way to think about it is it’s a sign of how healthy is our economy? Can businesses plan on revenues going up? Can workers plan on getting a wage increase next month? I mean employers got to have somewhere to pay for that from.

Years into the recovery the Federal Reserve really sat down and started an introspection on what happened. And really, it’s like what happened in the U.S. economy, not just like are our tools not working. And that’s what we’re seeing right now is the Fed trying to get us not just back to where we were in 2019, because frankly for more than a decade since the great recession they had failed at both their stable prices mandate as they defined it and their full employment mandate.

So, they want to actually get us back to somewhere better than February of 2020. But right now, they’re not even getting us there.

Even setting aside COVID, they were trying to solve a problem and the signal of the problem was this inflation that just wouldn’t get to where the Fed said it needed to be.

TONY ROTH: So, currently we know that inflation is running much higher than the Fed wants. But that’s because we’re comparing it to last year, where conditions were so soft and we’re also going through this reopening where there’s lots of supply chain disruptions so people are able to charge more for things because there’s not enough of it and we’re trying to figure out are prices going to come back down so that price growth is more at a stable, controllable, and healthy level of around 2% or so.

Before we talk about the future, let’s just make sure we understand the present. So, do I have that right in terms of how I described current conditions? The Fed also worries a lot about the labor market. The Fed is always trying to balance this dual mandate between price stability around 2% price increases, which is inflation, and full employment. So, maybe you could also tell us a little bit about how the Fed sees the labor market.

CLAUDIA SAHM: I think actually for both inflation and the labor market, what gets really hard is we see the headlines of the totals, like overall consumer prices rose 5% year-over-year, the U.S. economy added half a million jobs last month, right. And what’s happening, this is always the case, but it’s really the case right now is under those numbers are many different sectors, many different groups of households and when you just look at the number all rolled up, it—you’re missing a lot about what’s going on underneath.

So, in the case of inflation, like you said, some of why we’re seeing numbers bigger than that 2% that we’re kind of aiming for usually is last year inflation was really low. It averaged more like 1%. We didn’t talk a lot about inflation because the world was in freefall, jobs were being shed. But inflation was doing things that were very worrisome and you had some sectors, like airlines, gas, gasoline prices, that were falling, right. And so, particularly with airlines, not only do they need to rise, the prices, so that we’re back to kind of a normal level of operation. Frankly, they need to make up some of what they lost in terms of revenues last year.

So, I think this is where we can really be misled by just looking at the total month to month what’s going on. We really have to dig into the stories and that’s absolutely what you do in the labor market too. Service workers have had a very different experience than construction workers.

And to your question about what is the Fed looking at? They look at everything, right. Subatomic particles of data get ingested, the trying to make sense of them, frameworks and stories. And every day when another piece of data comes out, that whole process restarts.

Now, again, the Fed doesn’t have a crystal ball. They don’t necessarily know exactly how to parse all the pieces. But it’s really, really important that we look at it on the ground floor, not just the 20,000-foot view.

TONY ROTH: When you think about where inflation is right now, being at this high spike, if you will, and hopefully you’ve given us a bit of an indication that you think it’s going to come down, what will cause it to come down as we move forward? Is it that as the reopening continues supply chains will sort of sort themselves out? Is it that the Delta variant is going to counteract the demand the demand that we’ve seen? Are there other factors? What are the key determinants that you see here that will enable inflation to come back to a natural equilibrium that’s closer to the Fed target?

CLAUDIA SAHM: I would point to three key factors. But the primary one is COVID. And this is true for any part of the U.S. or the global economy. COVID has driven this crisis, both the public health and the economic crisis, from the beginning and it will drive it to the very end. And the supply chain issues are just one example.

In the inflation numbers, our supply chains often go back to countries that do not have access to the vaccine and they have had a lot more disruptions just in terms of keeping workers safe, keeping plants online than we’ve seen in the United States. So, things have been looking up. Vaccines in the United States coming out. Even in some of the emerging markets, places where we have our supply chains starting, it was getting better. Things were looking up.

The Delta variant is raising risks. It’s a risk and it’s getting larger every day. And that’s just an example of how COVID is not done with us, and we haven’t gotten this under control. In our neighborhoods and communities it may feel like it’s getting under control. But particularly with supply chain, it’s the global conditions that matter also.

TONY ROTH: I mean I was referring to the Delta variant as a mitigant, if you will, on demand. It would stretch demand out further.

TONY ROTH: But it sounds like you’re saying something different, which is that it’s going to be a continued disruptor on the supply side, which would be pushing inflation up, not down. So, I want to understand what you’re saying here.

CLAUDIA SAHM: So, yes and yes. What I wanted to start with was like these push on inflation, this—these supply chains are important. I think that they are temporary. Now remember, I said in the beginning temporary’s a fuzzy word. I don’t think we’re going to have this with us into this time next year. But that’s a while. That’s a temporary we’re waiting for a long time.

When I’m saying temporary is we’re not going to run 3% inflation this year, next year, in the years in the future. Like that’s when people talk about a persistent step-up of inflation. That’s the thing we’re worried about.

Now, the Federal Reserve, I as a forecaster, even a month or two ago would’ve said, well, by the end of this year we’re going to see it stepping down. We’re going to see that it’s temporary because it’s moving back towards two. Another wave of COVID, it could delay when that happens.

So, I think COVID, it just creates uncertainty, like which way this goes. So, I do think—I just gave it as the first one, not because it tells me it’s temporary, we just have to think about that.

So, now your second, where you said the COVID and the demand side. So, us feeling like we’re getting the vaccines and getting out, like that’s part of the push that got inflation up. We feel safer going out. We’re making up for vacations, seeing family we didn’t last year.

So, COVID pushed up this demand and everybody was going out at the same time. That’s going to dissipate, right. Less demand, the same amount of supply, even if supply chains don’t get fixed, but the same amount of supply, well, prices go down, or at least they stop increasing at such a high pace. Inflation is increases in prices, not the price level.

COVID gave a push. That push isn’t going to keep happening. We can only reopen once. Another thing that has happened this year is the federal government sent out another round of stimulus checks. They re-upped some of the jobless benefits. We had a $2 trillion rescue plan. That’s a lot of money in a $21 trillion economy.

The reality is you can only spend your stimulus check once, right. So, that helped support this demand. That’s also going to dissipate, hopefully not totally. The point of the rescue plan was relief. But it was also to give a push to the economy, get that ball rolling. But it’s not going to roll at the same pace.

So, a big piece of inflation is going to cool off as demand is going to cool off. What we need for inflation to step back down is to things to just cool off, not too much, but just a little bit.

TONY ROTH: So, some real important considerations here around the idea that you only go through this big demand surge once at the reopening. And, in addition to that, that demand surge is enabled by the fiscal stimulus, which is going to be rolling off. So, those are all mitigants to further up our pressure on prices.

One of the things that I’ve learned over the years of working with our economics team, Claudia, is they always talk to me about inflation expectations. I’ve learned the reason that they’re so obsessed with inflation expectations is not because it’s an indication of what people think is going to happen, but there’s actually a causal relationship between inflation expectations and what inflation does.

The markets themselves and the participants in markets have a big impact on what inflation turns out to be through their own behavior. And I thought it’d be really important if you wouldn’t mind explaining to folks the role that inflation expectations play in future inflation.

CLAUDIA SAHM: Absolutely. Inflation expectations come up anytime you put an economist or some talking head up to talk about inflation. So, I am a bit of an iconoclast in terms of inflation expectations. I think there’s not much there. But I do understand. I mean I have a—the standard training in macroeconomics. I have a PhD. I understand the logic behind it. Our models are often really, really nice on paper and then sometimes they completely fall apart when they march out into the real world.

So, what is this? Why does this matter? So, the thinking is if I as a consumer, and markets also try to think about this, if I as a consumer expect to have to pay more, maybe a lot more, you know, next year or the year after, well, then when it comes to the end of the year and I’m in with the boss and talking about what a great job I did last year and asking for that raise, I’m going to want to ask for more. Because I want to be able to buy everything I could buy last year and not always a little bit more. But given that I think prices are going up, I got to have even more in the paycheck. And that’s what can create this spiral.

Like I’ve changed my behavior as a worker, as a consumer, because I’m worried about inflation. This is one of the ways you can create an inflation cycle.

When these models were developed was in the 1970s. And in the 1970s you could say this dynamic could happen because we had a lot more labor unions. A lot of wage contracts were bargained. So, if the union steward sat down and said prices are—they’re high this year, and they were in the ‘70s, and they’re going to go higher, then they would go in and bargain for more. And you actually had labor market contracts that had the cost-of-living adjustment.

We do see workers getting higher pay and raises right now, For a very different reason. It has to do with the labor market. But it’s not impossible that workers get in a position where they can create bigger raises and then if they have a bigger raise, the employer has to raise their prices. So, you can get this dynamic going.

So, I’m not saying we shouldn’t watch it. But we have to think about really hard why would this matter and is this even plausible in a 2021 economy?

TONY ROTH: So, it sounds like the conventional view on inflation expectations is not something that you subscribe to, which is the fact that the market thinks inflation’s going to go up means that it’s likely to go up.

What about the Fed? Do you think that Chairman Powell and all of his tribe there in the Fed, are they as concerned with inflation expectations as we seem to be? Or do you think that they are more in your camp, that they think they’re not as important anymore?

CLAUDIA SAHM: Well, I absolutely don’t want to guess with Jay Powell is thinking or any member of the Federal Open Market Committee. I will say it’s kind of irrelevant right now, because the Federal Reserve changed its framework, the way it thinks about when should we raise rates, when should we stop, you know, trying to stimulate the economy, and they have moved, just in this past year, to an outcome-based monetary policy.

So, they used to all think about, well, is inflation coming? If inflation is coming—see, those are expectations—then we should go ahead and raise rates because it takes a little while for interest rates to go up and they cool the economy and we don’t want things going out of hand because, as you said in the beginning, if they wait too long and they really got to raise rates, that caused recessions in the past. So, the idea was if we think it’s coming, we want to get ahead of it and raise rates. This was their logic after the great recession, and they were wrong about raising rates at the end of 2015 because inflation didn’t come, and the labor market wasn’t done bringing people back.

So now they said, okay, we’re going to avoid that mistake. So now, we want to see inflation. We want to see inflation average of two over a period of time. Now remember, last year inflation was more like one, so they kind of need inflation of three to average two. In the frameworks that they have articulated, we haven’t seen this all the way through, but in the frameworks they have articulated, it is the inflation we actually see, not the inflation that the Federal Reserve thinks we will see.

I think we should think about what inflation is going to be. I think consumers should think about it too. But that is no longer a lynchpin of monetary policy under the framework.

TONY ROTH: In other words, the targeting of an average of 2% over time. And so, you know, again, what matters is the reality of where inflation is not the expectation of it.

So, one of the things that I have articulated in my own work and in my leadership of our business here at Wilmington Trust in trying to figure out what’s happening in the world, and I’d love review on this, Claudia, is the idea that the Fed cares very passionately about its own relevance and consequently it cares about its effectiveness, and it cares about having tools that will work. For all that to occur, it can’t be up against the zero bound of rates in order for it to continue to be able to be important.

So, out of this whole cycle, one of the things that’s probably very dear to the Fed is the idea that it can help manufacture, create in some way, enough inflation so that it can get the Fed policy rate off of the zero bound so that the next time that we have an economic crisis it can be in a position to lower rates and be stimulative

I’d love to know if you think I’m missing something fundamental, or do you think that that sums up a good part of what the Fed thinks about?

CLAUDIA SAHM: The Fed is facing a real challenge. And one of those challenges is very much related and is exemplified in the zero lower bound, this is not a new problem. This was a problem that had been brewing for decades, because interest rates, long-term interest rates for decades have been falling in United States.

It is, in fact, the case that over that same period growth had been slowing too. So, if you look at GDP growth, it was slowing, and demographics were aging. There are global factors.

So, all of these things and probably some other factors were coming together and bringing down rates. Now, that’s great if you want to buy a house or a car and that’s great for the federal government if they want to borrow and do spending. It’s not so good for the Federal Reserve when their primary tool to stabilize the business cycle, both get things going in a recession and kind of cool it off when the expansion gets going a little too hot. Their tool are interest rates.

In a low interest rate environment, it really doesn’t work that well. It’s not the Fed’s fault. It’s just the world changed. They’re still working through interest rates. The reason they did that was not just for the heck of it. It was because they realized the tools they’ve been using, the approach they’ve been using didn’t have the same kick that it used to.

Now, the new framework, the average inflation targeting, on its own that is not getting us off the zero lower bound– inflation isn’t what pushed interest rates so low. It’s these bigger factors in the economy, factors in the global economy.

So, what the Fed is trying to do right now while still staying independent of Congress is they’re trying to stay out of the way, because at this point the way we get really off the zero lower bound, not just, you know, getting out of this recession, the recovery, it’s getting up long run growth, getting this economy really going. Now, we’d rather not have a ton of inflation with it. But we need to get things firing on all cylinders again in a way they haven’t for decades.

Congress, if they do it well, like the infrastructure spending, other investments in say our children, our future, like that could get the growth going. At this point, interest rates are so low if you’re a business and you’re not investing it is not because, oh, I’m just waiting for another quarter point off the interest rate, the fight is a bigger fight. Congress is the only one that can actually kick things back into a higher gear.

The Fed can’t. But the Fed could get in the way of it, right. So, they’re trying to let Congress go, but only in a “it’s good for growth.” If the Fed thought things were getting out of control, inflation was a problem, they would raise rates. Like they are fully independent, and they will, even more than their credibility, defend their independence to the very end.

TONY ROTH: Yeah. I mean it definitely seems like access to capital is not a problem in the economy. And if the Fed needed to raise rates in order to keep inflation at bay and raise the policy rate from 0.25% to 1% or 1.5%, you still have access to capital. It probably would actually end the cycle and the expansion, but not because it would be slowing down the access to capital, but rather that the markets have been trained to go through a cycle where there’d be deflation in asset values and that deflation in asset values would actually then have a cascade through the economy and trigger a recession. And that, ironically, is what would trigger the recession, not actually a more limited access to capital or a more restrictive approach to monetary policy in and of itself.

CLAUDIA SAHM: In no way do I want to say that the Fed is impotent and they’re not able to do anything with the economy. We’ve certainly seen the contrary case last year, especially in the spring. But at this point, it’s not the interest rate so much. It’s the signaling from the Fed. It’s the communication. If the Fed were to raise interest rates, that’s telling you, oh wow, inflation is really heating up. We need to get this under control.

Inflation that potentially might not get under control right away, well, that’s really not good for bond markets. So, in some ways markets have gotten to the place where they react largely to what the Fed is trying to do. I mean a quarter percentage point on an interest rate is not a make-or-break. But when the Fed raises a quarter of a percentage point, the markets are going to react to that, because that tells you something about how the Fed is looking out at the economy. And, you know, you don’t bet against the Fed, right.

So, if they’re, if that’s their view, it really means something. So, it’s they have tools still. They’re just not the tools they had before. And it’s actually kind of frightening that like one word or two or some dot on a forecast plot can move markets.

TONY ROTH: Well, what do you think about these dot plots. I mean, they were so obsessed that if two more governors moved their forecast from 2022, 2023 to 2022, that means the first hike is next year instead of the following year and the markets are not priced for that.

Now, we have so much excess of communication that it almost feels like the communication is ineffective. But do you think the dot plots are worth looking at at all?

CLAUDIA SAHM: If I had the ability to, I would throw the dot plots in the wastebin. I have been a critic of them. I was at the Fed when they were developed—I know more of their origin story than probably is in the outside world.

But it made sense when the Fed’s policy was based on these forecasts, right. We think inflation is coming. Then I might care about the individual forecast of every member of the FOMC. Not everybody’s vote is as important. Like I’d really like to know Jay Powell’s dot, his is really important. And a few other people, like New York Fed, John Williams, his dot is really important.

But it doesn’t make any sense anymore because the monetary policy framework is outcome-based. I really don’t care what any of them think is going to happen next year or two years from now. Nobody can forecast that far out.

So, they should be talking about this in private. They should be thinking conceptually about, hey, are things getting out of control. But there is zero reason to put those dots out to the world. I mean the Fed is doing such a good job at being boring. Like, Jay Powell says the same words, transitory, transitory and so those dots people need something. They’re looking for any scrap of information from the Fed and a couple dots bouncing around, that becomes news.

TONY ROTH: Let me play devil’s advocate. Is there a level on which the dots have been useful for them of late because it’s a way to provide reassurance to markets, to keep markets inflated in a sense that if markets know that they’re not going to raise for at least another 12 months or more, than markets can maintain their levels and not deflate in the face of rising interest rates, you know, risk markets. And so, it’s a mechanism for the Fed to reassure financial markets globally that we’re going to stay in an extremely accommodative environment because the dots are so far out and it just keeps everything at bay and it allows the markets to continue to inflate. It’s another mechanism, if you will, to provide that reassurance, a very, very specific one.

CLAUDIA SAHM: So, I am not an investor. I’m not putting any of my money on the line and certainly not any clients’ money. And it absolutely depends on your trading strategy what you need in terms of information. If what you’re trying to do is understand, what should be my baseline expectation of forecast over the coming years and how should I think about the risks, the Fed is very good at filtering the information. Like there are 400 PhD economists at the Fed who are cranking through all of the numbers.

So, yeah. When the Fed talks, when the Fed writes down their dots, I mean there is thinking behind them. Everybody’s taking this exercise seriously. However, the information about what’s happening this year is probably some of the best information we get. In 2023, nobody’s got that information, right.

TONY ROTH: Right. Too far away.

CLAUDIA SAHM: You might need for risk assessments. And then what I would say is when you—and you mentioned this about too much information from the Fed. Listen to Jay Powell. He is the one member of the Federal Open Market Committee that never speaks of his views. He is always the mouthpiece of the Fed. And it has been historically unprecedented for a majority of the Federal Reserve officials to vote against the Chair. So, if you think that’s happening, I’d put a pretty low chance on it.

For example, if tapering is going to happen soon—not purchasing as many of treasuries and the market-backed securities, which is another way they’re putting downward pressure on interest rates, if that’s coming and the Fed will signal it because they don’t want to get people all rattled, it won’t come first from Jay Powell’s mouth. It will come first from someone on the board. They test the waters. I don’t guarantee this is going to happen. But this is the way they’ve done this in the past, and they try very hard to like ease us into a change. The Fed does not like change that happens rapidly, and markets don’t either, right. There’s no reason to do this.

So, but then by the time that Powell is talking about it, it’s really happening.

TONY ROTH: One more question on the Fed, very specific one, a very practical one. So, we know that when the Fed starts to remove the accommodation, as it likes to say, the first thing it’s going to taper its quantitative easing. And by quantitative easing what we mean is the Fed’s going out into the market and buying treasury and even mortgage securities and propping up those markets, being a buyer in those markets, making those assets more valuable and, therefore, making it easier for people to buy homes and refinance them.

So, there’s a lot of speculation, Claudia, that whether it be in Jackson Hole or whether it be in September meeting, the Fed is going to be much more specific around when it’s going to start to taper these asset purchases. And, of course, this quantitative easing, these asset purchases, are, in fact, the big new tool that the Fed has developed over the last decade. But it’s certainly not a traditional tool and probably not one that a lot of folks are comfortable with the Fed engaging in for undefined periods of time.

So, do you think that this tapering will actually happen this year? And if so, what will be the decisive factor that enables the Fed to get over this hurdle and start with the tapering?

CLAUDIA SAHM: Well, I think what’s interesting, the quantitative easing. I think back to what you were saying about the Fed wanting to get off the zero lower bound. The only reason the Fed developed this tool is because back in 2008 they took the federal funds rate all the way to zero and it was clear they needed to do more. So, this tool was not sitting in the toolkit in 2007. And it’s one where Bernanke, who was then Fed Chair, Ben Bernanke, he said years into it quantitative easing worked but we don’t really know why. The theory wasn’t there and there’s been a lot of discussion about whether its effects on financial markets above and beyond this helping push interest rates down, if they were really worth it.

I think they were. But it’s absolutely something we should be debating. And I think if we got off the zero lower bound, we would never talk about quantitative easing again. Like they would be happy to put that one aside.

But they can’t. I mean that’s not the world we live in. What they’re doing is they’re buying all these assets. The Fed can print money. They can go out and buy as much as they want to, and it piles up. And it piled up after the great recession. And this tapering, all tapering does is it means every month I go buy a little bit less. I’m still buying.

It wasn’t until much later in the last recovery that they actually started selling. They never sold off all these assets and here we go into another recession, and they are buying them again at lightspeed and then they’ll slow it down and eventually they’ll pay it off. I mean are they really going to ever pay this off? I would love to have debt like this I never have to pay off.

At some point they just, it’s like taking the foot off the accelerator, buying a little bit less. So, that’s what this tapering is called. And it has been a huge discussion in market, like when is this going to happen, what meeting?

It has to do with the calendar of when the Fed meets and when they would have time to vote on it. And remember, they don’t want to surprise anybody. So, they’re going to need some time. Like the Jackson Hole speech in August and then there’s a September meeting and Oct. Like it’s going to take some time to message it.

So, I really think at the earliest we would see in December them making a definitive we’re going to do this soon, because they’re going to have to build up to it. I think Delta variant and the questions—

TONY ROTH: Yeah. That’s what I was going to say.

CLAUDIA SAHM:—it’s raising about the robustness of the expansion because they’re going to want to see too what is this really going to do? So, I think in a best case, say Delta doesn’t matter, say the recovery keeps going, say inflation doesn’t get out of control, it steps down. I think, you know, we could see tapering start happening early next year. I think that would be a good case. And we’ll know a lot more. At their meetings we’re going to get more and more information.

But I could see them in December saying, hey, we’re going to do this and we’re going to do it next quarter, you know, and they get going. If things start slowing down, I still think we’ll see tapering next year. But it could be, you know, towards the end of the spring, like a little bit later. A month or two ago there was a lot more discussion of like, oh, Jay is going to signal it at Jackson Hole, which is late August and then things are going to get going by the end of the year. And with Fed watchers and analysts, that’s still out there as a story but it is looking less and less like they’re going to get moving that fast.

TONY ROTH: That’s very, very interesting. And I don’t know that markets are necessarily priced for that. Although, maybe that—maybe they are and that’s why the 10-year has come down so much is that, you know, there’s this excessive dovishness, if you will, in markets right now.

So, last question I wanted to ask you is a very practical one, which is here at Wilmington Trust we have an—a forecast for GDP. And so, we think for 2022, next year, and for 2023, we think that GDP is going to settle in at a level that’s going to be higher than it had been prior to COVID, higher than the trend, if you will, the trend being probably 1.6%–1.7%. And doesn’t mean that we’re going to stay there for long, but at least for the next couple years we’re going to probably do, you know, maybe closer to 3% growth because a lot of the growth that we thought would happen this year will get pushed out due to the Delta variant and other factors and it may take a lot longer for a lot of the built in $3 trillion of additional spending to come out into the economy. We think the administration is likely to find a way to continue to engage in more deficit spending and has typically been the case in non-recessionary periods.

But so, we’re looking at 3%-plus growth in 2022 and 2023, which again is higher than the long-term trend and underwrites our view that we still think that equities are a good buy. I’m not asking you at all to comment on our investment thesis. But I’m wondering if you could comment on our economic outlook thesis, that we will have at least another couple years of growth that’s higher than that trend of 1.7% or so.

CLAUDIA SAHM: Running around 3%, that’s a good bit above pre-COVID trends. So, to get that you really do need to see these big fiscal packages go through, not just a trillion-dollar infrastructure plan, because that takes a while. But the discussions that are going on about, say, a $3.5 trillion plan, like that’s what gets you 3%, next year, the year after. You could stay 2.5% after that.

That’s where you get like the trend coming up, because we get productivity. We just get like labor markets working better, product markets working better. I spend a lot of time, not just monetary policy, fiscal policy, and every day I become more and more worried about those big fiscal packages coming out. And if they don’t and they got to start happening soon. The political constellation is almost certainly going to change with the mid-term elections next year. So then, you know, if that doesn’t come, well then I think that’s going to be a tough forecast to hit.

I think Delta is a risk right now. I’m not sure I would build that into my this is what I think is going to happen. I mean COVID is receding. That’s going to help continue to boost growth, not just this year but I think now into next year as well.

I, I’m with you and I see the logic. I’m just afraid. And any forecast there’s always conditioning, right. Like you make assumptions under where you end up as the top number and I think I’m, I am concerned, though I still think it’ll happen, I’m really concerned about the partisan dysfunction and the chances of really getting the infrastructure, the investments in the kids. That would help so much in terms of longer-run growth. And I’m just not sure they’re going to get it together.

So, I hope you’re right. I hope we’ve got 3% growth and inflation under control. That’d be great.

TONY ROTH: Well, I think we’re, listen, we’re in agreement that a forecast has preconditions to it, as you said, and one of our preconditions is that we continue to have an expansive fiscal policymaking agenda in Washington. And if we don’t, if that’s not effective, then I think that that really calls into question. And the midterm elections will be important, no doubt, in that.

So, Claudia, thank you so much It’s been a great conversation. And let me sum up for as I always do three key takeaways.

First is that, yes, inflation’s moving up. Inflation’s higher now. But it’s not a cause for panic. As we see, we’re only going to have one reopening, we’re going to have a roll-off of a lot of the fiscal stimulus, and eventually demand will normalize, supply chains will sort themselves out, although there will be a little bit of additional kinks due to the Delta variant, but they’ll work themselves out and inflation will come back down to acceptable levels. In fact, they may come back down to levels that are much healthier from a monetary standpoint if they’re able to give the Fed some room to get off of that zero bound that we’ve talked so much about today. We’re actually pretty happy with where inflation is, and we think the Fed is probably very happy with where inflation is and where it seems to be headed right now.

The second takeaway is that it’s important to remember that quantitative easing and rate hike decisions depend on more than just inflation. The Fed is looking at not just inflation and also the labor markets, but also GDP growth, expectations around fiscal policy, and also where financial markets are. And the Fed is acting in a way that is going to be hopefully through its communications, we talked a lot about communications today, minimally disruptive to financial markets because financial markets themselves feed into levels of economic activity and price stability.

And so, it’s a very complex quilt of factors that the Fed is trying to balance here in deciding how to pivot towards a less accommodative policy. But as Claudia has said, again, with the Delta variant it may be pivoting to that in a little bit more gradual manner than we had thought even a couple months ago as we see this Delta variant continue to take hold and really impact activity across the world.

And the third takeaway one is that as we come out of this COVID situation, it may be more of a living differently with COVID situation than we expected, and it may mean that this big economic boom that we were expecting will be a slow but sustained economic expansion over a longer period of time. And in the beginning of that period, where we are today and into next year and even the following year, we may settle into a growth pattern that’s a little bit higher than we’re used to, especially if we continue to have the fiscal agenda in Washington see success.

And so, that’s something that we need to keep a very close eye on. It is to a large degree what allowed us to claw ourselves out of this deep recession after two short quarters and that fiscal support, while we could have lots and lots of other conversations around what it means for the dollar and for the long-term health of the country, certainly over the shorter-term it is a positive for GDP and economic activity.

Again, thank you, Claudia, for being here today. It’s really been a pleasure to talk to you.

CLAUDIA SAHM: Thank you so much.

TONY ROTH: I encourage our audience to visit wilmingtontrust.com for a roundup of our investment and planning content. You can subscribe to Capital Considerations on Apple Podcast, Spotify, Stitcher, or your favorite podcast channel to ensure you get updates on future episodes. Thank you again for listening.

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