Inflation, Interest Rates, and Janet Yellen

·20 min read

Welcome to the Capital Note, a newsletter about business, finance, and economics. On the menu today: Yellen says something (and then unsays it), Joe Biden, Peronist, Biden and Brussels against Ireland, and Richard Nixon and Arthur Burns. To sign up for the Capital Note, follow this link.

Yellen’ Fire
No, that’s not what really what Treasury Secretary Yellen did on Tuesday, but sometimes the lure of a bad pun is too hard to resist.

CNBC had a more sober assessment:

Treasury Secretary Janet Yellen conceded Tuesday that interest rates may have to rise to keep a lid on the burgeoning growth of the U.S. economy brought on in part by trillions of dollars in government stimulus spending.

“It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat,” Yellen said during an economic seminar presented by The Atlantic. “Even though the additional spending is relatively small relative to the size of the economy, it could cause some very modest increases in interest rates.”

There are plenty of caveats included in those remarks (that “maybe,” and even the “somewhat” was qualified by a “very modest”), but, if I had to guess, that with so much inflation talk in the air, Yellen saw some value in sending out a message (not least to any Democratic lawmakers beginning to balk at the amount of planned spending) that the administration was (a) aware of the risks and that (b) it could be dealt with by an only modest course correction.

However, someone must have thought that this was the wrong thing to say. Yellen “walked back” her comments within hours of their release.

The Wall Street Journal (from later on Tuesday):

Treasury Secretary Janet Yellen said Tuesday she is neither predicting nor recommending that the Federal Reserve raise interest rates as a result of President Biden’s spending plans, walking back her comments earlier in the day that rates might need to rise to keep the economy from overheating.

“I don’t think there’s going to be an inflationary problem, but if there is, the Fed can be counted on to address it,” Ms. Yellen, a former Fed chairwoman, said Tuesday at The Wall Street Journal’s CEO Council Summit. . . .

Some economists, including former Treasury Secretary Larry Summers, have warned that a burst of federal spending this year stemming from the $1.9 trillion Covid-19 relief package enacted in March could prompt unwelcome inflation.

Ms. Yellen said she expects to see some price pressures over the next six months, largely because of supply-chain bottlenecks, higher energy prices and a near-term demand for workers, as normal economic activity resumes. But she said she disagreed with Mr. Summers that the relief package would overheat the economy.

The Financial Times also weighed in, sternly observing that “it is not advisable for a Treasury secretary to comment on monetary policy”:

Plenty of holders of the office have tried to use “open mouth operations” to influence monetary matters — including the value of the dollar relative to other currencies; it has rarely worked out well. The uneasy compromise between the US Treasury and its central bank — dating from the accord of 1951 — requires each to respect the other’s role. Plenty have not: President Richard Nixon intimidated his Fed chair in the 1970s to try to keep rates low [please see some discussion of this in today’s Random Walk, below]; Alan Greenspan, a former Fed chair, inappropriately endorsed tax cuts in the early 2000s.

However, the FT’s editorial board generously noted that Yellen’s comments “were not particularly egregious,” nor were they that dramatic, “she did not say the economy would overheat, only what the Fed should do in response.”

The newspaper read the politics of her comments differently from me:

[The comments] suggested the Biden administration is not entirely convinced by the arguments of economists and commentators that the economy should be “run hot” to draw new groups into the workforce, reduce inequality and encourage companies to invest in labour-saving technology.

Or, I presume, it could suggest that there are divisions within the administration.

And when it came to the likely reaction her comments, the FT’s view, contrary to my informed opinion guess that her message would be comforting to waverers, was that her comments risked giving ammunition to those opposed to the spending package in that they could “quote back her words on the risk of overheating.”

The FT concludes:

Whether or not the spending package will lead to an overheating economy is a judgment call: no one knows the extent of the damage done to productivity by the pandemic or what it would take to change inflation expectations. Sensible economists know this, and Yellen is nothing if not a sensible economist. Her new career, however, will sometimes require her to behave instead like a sensible politician.

There is a lot going on in those final two sentences.

So far as expectations are concerned, whether in the markets or on Main Street, there is plenty to feed inflation expectations, expectations which, of course, famously gorge on themselves. Check out the price of many commodities (for example, take a look at the price of “doctor” copper, up from a little over $5,000 per ton a year ago to $10,000 now) or in the grocery stores. And nerves are clearly on edge.


Mentions of inflation on first quarter corporate earnings calls have exploded 800% year-over-year, according to new research from Bank of America Securities strategist Savita Subramanian. By sector, inflation was most prevalent in materials, consumer and industrial companies. Most sectors have cited inflation more than the historical norm, Subramanian notes . . .

“We are seeing substantial inflation,” Berkshire Hathaway CEO Warren Buffett said at the Berkshire Hathaway annual shareholder meeting exclusively live-streamed by Yahoo Finance. “We are raising prices. People are raising prices to us, and it’s being accepted.”


BlackRock’s Rick Rieder told CNBC on Tuesday he frequently has discussions about whether the U.S. economy will run too hot, too fast in its recovery from the coronavirus pandemic.

“Listen, every client call I’m on including the one I just finished . . . is talking about overheating,” the chief investment officer of global fixed income at the world’s largest money manager said on “Halftime Report.”

“Everybody is talking about overheating,” added Rieder, who oversees more than $2 trillion of BlackRock’s $9 trillion in assets under management.

Almost Daily Grants:

Mr. Market has spoken, and inflation is on the way. From Bank of America on Tuesday:

“U.S. 5-year, 5-year forward inflation swaps [i.e., the price rises investors expect from 2026 to 2031] are pricing inflation consistent with the highest we have seen the past five years. This is not about base effects given last year’s weakness, not about anything temporary.”

Similarly, with a whopping 16.5% year-to-date advance, the Bloomberg Commodities Index is off to its best start on record going back to 1973.

And there is plenty to fuel fears in the press, not least this headline in yesterday’s Wall Street Journal:

Everything Screams Inflation

As yet, conventional measures of inflation expectation, whether it’s yields on the ten-years or increases in wage pressure, show few signs of a take-off. In case of the former, there has been a sharp rise from last year’s trough, but it’s hard to see the current yield of 1.6 percent as high in any absolute sense (would you lend to Uncle Sam over the next years for that?), even if the Fed’s interventions are keeping rates lower than they would otherwise be. Meanwhile, jumps in wage rates appear to have been largely attributable to base effects, as well as changes in the composition of the workforce (lower-paid workers were more likely to lose their jobs).

On the other hand, look elsewhere. On top of the price rises described above, there are plenty of signs of asset-price inflation, from houses to stocks to collectibles. While part of the surge in crypto currencies is purely speculative, it is hard to see it as a ringing endorsement of the purchasing power of the dollar.

Then there are stories such as this (from NBC, a couple of weeks ago):

Shoppers had better start budgeting more for their groceries, according to the latest consumer price index, which shows prices are increasing — and they’re likely to keep going up.

The monthly consumer price index, released Tuesday morning by the Bureau of Labor Statistics, showed a 0.6 percent increase in March, the largest one-month increase in nearly a decade. Over the past year, prices have increased by 2.6 percent overall.

Gas skyrocketed by 9.1 percent last month. Since February, prices of fruits and vegetables have risen by nearly 2 percent, and the index for meats, poultry, fish and eggs has risen by 0.4 percent, according to the government figures.

The spike comes on the back of prices that had already risen during last year’s pandemic stockpiling and supply chain disruptions and never went down. Consumers are noticing their inflating receipts.

Outside a supermarket in Long Island, New York, John Kermaj said he has seen prices rise in just the past two months.

“We used to buy this stuff for $30. Now it’s $60,” he said.

He has tried to adapt when shopping for his family by buying only essential items and avoiding name brands, but that means skipping meat and fresh fish.

“Gotta be the pandemic,” Kermaj said. “Shortage.”

Before the pandemic began, the national average for a pound of bacon in January 2020 was $4.72. By last month, the price had soared to $5.11, according to exclusive supermarket point of sale data from NielsenIQ. Ground beef is up to $5.26 a pound, from $5.02. Bread is up to $2.66 a loaf, from $2.44.

The administration needs to hope that not only is John Kermaj right, but that most people (and, indeed, the markets) will agree with him — that this is a temporary, pandemic-related thing, a function of disrupted supply chains, amplified by firms cutting back on inventories to hang on to cash, and then compounded by the unleashing of pent-up demand.

Take a look at car rentals.

David Lynch and Yeganeh Torbati writing for the Washington Post:

Major rental car operators last year sold off more than 770,000 cars as the pandemic crushed demand and kept Americans home, according to Jefferies Group, an investment bank. More than one of every three rental cars that were in service before the pandemic are no longer available.

For customers, smaller fleets mean higher prices and longer waits. But for the rental companies, shedding car leases and cutting billions of dollars in planned purchases was the key to survival. Now that the economy is growing faster than anticipated and people want to travel, the companies are struggling to find enough cars.

“Usually car rental is an afterthought,” said Benjamin Tuttle, a computer-assisted design programmer from Minnesota, who was taken aback when Hertz quoted him a price of $240 per day to rent a sedan to tour Colorado’s Rocky Mountain National Park.

Reasonably enough, Lynch and Torbati put this story within its wider context:

The industry backfire illustrates that the post-pandemic recovery, while strong, may not be entirely smooth. As more retail businesses reopen, many report trouble hiring enough workers to cope with surging demand. Manufacturers complain that raw materials are scarce — a semiconductor shortage that hobbled auto production is making it hard for companies like Avis to restock.

“The covid shock was unlike anything we have experienced before. As we go into the recovery phase, we’re going to see friction and disruption in the normal flow of economic activity,” said Kathy Bostjancic, chief U.S. financial economist for Oxford Economics. “It’s going to be a bit erratic and disrupted, but the pace of growth will be very strong.”

Combine strong demand with supply shortages and higher prices will always be the result. The question remains whether the effects of these dislocations will last long enough to change expectations for the longer term, expectations that will only be fired up further by the planned spending packages, and may indeed be justified.

Larry Summers, no GOP stalwart, has been on record for some time about the inflationary dangers represented by President Biden’s $1.9 trillion package (this was during the halcyon era before the president set out his plans to become the $6 trillion man), and recently returned to the debate.

The Hill:

“Look, economists don’t know what drives this stuff. They’re not sure,” he said.

But he added that based on a variety of theories, the numbers were cause for concern.

“There’s an output gap-type theory, which I tend to subscribe to. That is flashing red alarm. There’s a monetarist theory that looks at money aggregates. That is flashing a red alarm. There is a fiscal theory that looks at the ultimate consequences of deficits. That is flashing a red alarm,” he said.

Apart from that . . .

Considering everything, there is a very good chance that people and markets will not be inclined to believe that the jump in inflation is temporary and will adjust their behavior accordingly, turning the temporary into something more sustained. In an article for Capital Matters the other day, John Cochrane and Kevin Hassett wrote that “when people question policy and find it feckless, they expect more inflation, and inflation grows more and becomes entrenched.”

Well, maybe it’s just me, but I think that the administration can check the “feckless” box.

And then what?

Cochrane and Hassett:

Will our Fed, and the government overall, have the stomach to repeat 20 percent interest rates, 10 percent unemployment, disproportionately hitting the vulnerable, just to squelch inflation? Or will our government follow the left-wing advice of 1980, that it’s better to live with inflation than undergo the pain of eliminating it?

Moreover, stopping inflation will be harder this time, in the shadow of debt. Federal debt held by the public hovered around 25 percent of GDP throughout the 1970s. It is four times that large, 100 percent of GDP today, and growing. The CBO forecasts unrelenting deficits, and that’s before accounting for the Biden administration’s ambitious spending agenda.

If the Federal Reserve were to raise interest rates, that would explode the deficit even more. Five percent interest rates mean an additional 5 percent of GDP or $1 trillion deficit. The Fed will be under enormous pressure not to raise rates.

To repeat myself, and then what?

The markets were mixed on Tuesday, with the Dow slightly up, but the S&P and the NASDAQ both down.


Reasons for the downward pressure varied, but strategists cited a mix of concerns about rising inflation, fears the Federal Reserve may have to taper monetary stimulus earlier than telegraphed, and the potential for tax increases in the months ahead.

Oh yes, tax increases. There are those too.

Then again, the S&P rose yesterday, and the Dow hit a record, so all must be well.

Around the Web
This is not altogether encouraging . . .


Argentine Vice President Cristina Fernández de Kirchner (CFK) Monday was full of praise for US President’s Joseph Biden’s message before Congress, citing resounding Keynesian resemblances to her economic policies both in the current term since 2019 and also when she was President between 2007 and 2015.

“Does it sound familiar?” Fernández de Kirchner posted on Twitter. “Life is full of surprises,” she added given Biden’s announcements regarding taxation for the wealthiest and the creation of jobs.

“Why did Biden say all this?,” CFK wondered. “The worst pandemic in a century, the worst economic crisis since the Great Depression, the worst attack on our democracy since the Civil War,” she went on, adding that unlike in her case against incumbent Mauricio Macri in 2019, “the IMF did not finance (former President Donald) Trump’s campaign,” about Macri’s free rein borrowing from that body in 2018.

CFK also highlighted Biden’s words for the people of Wall Street, when he said “Wall Street didn’t build this country. The middle class built the country and the unions built the middle class. That’s why I ask you to the Congress that approves the Law to protect the right to unionize . . .”

Cristina Kirchner, who is not only a former president, but the widow of another, is a politician in Argentina’s Peronist tradition. At the beginning of the 20th century, Argentina was one of the richest countries in the world. That is no longer the case.

Competition works (again)

Bloomberg (my emphasis added):

Apple established the 30% tech tax starting nearly two decades ago, with the iTunes Store. It took about 30 cents of a 99-cent song and used the same model when it introduced the App Store in 2008. The fixed 30% fee has since sparked a global war between software makers and technology giants, leading to antitrust scrutiny in Washington and Europe and fierce corporate lawsuits, such as the Epic Games Inc. trial against Apple over developer fees, which kicks off Monday. At stake are tens of billions of dollars annually and future control of the app economy currently dominated by Apple and Alphabet Inc.’s Google.

But there are already signs the 30% rate, long standard across the tech industry, is dying, regardless of courtroom verdicts or government intervention. Last week, Microsoft Corp. said it’ll soon reduce its take from PC games sold through the Windows store to 12%, from 30%. In March, Google’s Play store halved its 30% developer fee to 15% for the first $1 million in revenue each year. Even Apple chopped its 30% cut in half for developers generating $1 million or less a year.

But for larger developers on Apple’s platforms, such as Spotify and Epic, which are still subject to the 30% fee, the fight goes on. They’ve claimed these fees are too high and anti-competitive and that the major app stores often have convoluted, if not arbitrary, rules, including Apple forcing them to use its proprietary billing system. Apple, meanwhile, has argued that the tremendous success of their mobile products has birthed a massive business for developers and that it has every right to share in the spoils, citing its investments in platform development and oversight. Apple has also noted that it takes a 30% cut of subscriptions only for the first year and then just 15% afterward.

While this drama plays out, it’s inevitable the economics of the app ecosystem will continue to evolve. This is partly due to ongoing public pressure. On Friday, European Union regulators said in an antitrust complaint that Apple is abusing its power as a “gatekeeper” for app makers. Apple responded that the EU’s “argument on Spotify’s behalf is the opposite of fair competition.”

Charging less can be a competitive advantage. Microsoft’s move last week gives game makers an enticing reason to prioritize the Windows store over Valve Corp.’s Steam, which still charges a 30% fee. Likewise, Spotify, in building out its paid podcast network, said last week that participating in its subscription platform will be free for the next two years and then require a mere 5% cut of revenue starting in 2023. That’s significantly less than the 30% of sales Apple will take from podcast subscriptions in their first year.

What might eventually kill the 30% fee for good is customers realizing they’re the ones often footing the bill. When my wife found out she had needlessly paid an extra $130 to Apple for her Spotify subscription, she immediately cancelled and set up a new account directly with Spotify. Apple’s cut of those sales? 0%.

Biden and Brussels unite against Ireland

The Spectator:

It now looks as if Ireland’s low-tax miracle is over. First, President Biden, despite getting sentimental of his family’s roots in County Mayo whenever he faces an electorate he thinks might celebrate St Patrick’s Day, is proposing a global minimum corporate tax rate of 21 per cent. That won’t make a lot of difference to France (28 per cent), or Germany (30 per cent) or indeed the UK (19 per cent, rising to 25 per cent). But it will make a heck of a big difference to Ireland. In effect, it will have to double its rate. Now the European Union has joined in. According to a report in the Irish Times, the Commission is pushing for the Irish to end its tax breaks as a condition of receiving its share of the money set to be distributed through the €750 billion Coronavirus Rescue Fund. Raise taxes or you don’t get the cash is the message from Brussels.

In fact, the EU’s position is very odd. Ireland is a net contributor to the EU’s budget, now that the UK has left, so it will be a net contributor to the Rescue Fund as well. In effect, Ireland is being told that in exchange for paying for a bail-out for Italy and Spain it will be forced to wreck the competitiveness of its own economy.


Random Walk
This extract comes the forthcoming Money and the Rule of Law: Generality and Predictability in Monetary Institutions by Peter J. Boettke, Alexander William Salter, and Daniel J. Smith, an intriguing new look at the basis on which central banks (and, specifically, the Fed) should be operating. (Spoiler: It’s not the way they are operating now.)

This book is a serious, and closely reasoned, piece of work, but that is not to say that it doesn’t have its lighter moments, on this occasion provided by none other than Richard Nixon. Well, “lighter” isn’t quite the word — we’re talking Dick Nixon here — but you’ll see what I mean.

Please note that this extract has been lightly edited and citations removed:

Once elected, President Richard Nixon moved at his first opportunity to replace Chairman Martin [William McChesney Martin, Fed Chairman 1951-70], who he blamed for both his previously failed presidential bid and the recession of 1969. President Nixon appointed Arthur Burns as Chairman in 1970. As a close acquaintance and advisor, Nixon believed that Burns would provide accommodative policy. On the day that Burns was officially appointed as Chairman, Nixon joked, “I hope that independently he will conclude that my views are the ones that should be followed”, and directed to Burns, “please give us more money!”. With his mandate from President Nixon, Chairman Burns acted to consolidate Fed decision-making within his office. He spent a considerable amount of time shaping the views of the FOMC toward his own. For instance, Burns prolonged meetings to get agreement by attrition. Chairman Burns also created a new rule requiring that the chairman directly approve all Fed reports. Dissenting governors were swiftly punished. For instance, in one case, Chairman Burns brought in the FBI to investigate, and in another, asked President Nixon to appoint a governor as an ambassador. Chairman Burns also expanded his authority over appointments to the presidencies of the Federal Reserve Banks by requiring that directors of the Federal Reserve Banks submit multiple names for his approval, rather than just one candidate.

Despite the stagflation that emerged in 1970, Chairman Burns maintained an expansionary monetary policy in exchange for President Nixon agreeing to pass wage and price controls. President Nixon apparently told an aide that if Burns did not cooperate, he would “get it right in the chops” . . .

The Nixon tapes provide substantial evidence of pressure directed toward Chairman Burns. For instance, in one meeting President Nixon told Chairman Burns “You’re independent (laughter), independent (laughter). Get it [the money growth rate] up! I don’t want any more angry letters from people . . .”


— A.S.

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