Fed Restraint Will Likely Keep US Recession Mild, Blinder Says

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(Bloomberg) — The US is probably headed for a recession but it’s likely to be a mild one, in part because the Federal Reserve will be wary of raising interest rates too far, the US central bank’s former Vice Chair Alan Blinder said.

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Blinder, who’s out with a new book entitled “A Monetary and Fiscal History of the United States, 1961-2021,” said the current Federal Open Market Committee is more dovish than some in the past. He expects Chair Jerome Powell and his colleagues to raise short-term interest rates to 4.5%,  then stop to see if sky-high inflation is coming down. 

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“My guess is this FOMC will be wary of overshooting in the way some past FOMCs were not,” said Blinder, now a professor at Princeton University. 

While the US could still skirt a recession, the odds against a soft landing are well under 50%, Blinder said — but the severity of any downturn will be cushioned by the stockpile of extra savings that many US households have built up during the pandemic. 

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In an interview, Blinder discussed the last 60 years of fiscal and monetary policy making — including why Team Transitory may ultimately be proved partly right on inflation, ex Fed Chair Alan Greenspan’s belief in “laissez fairy tales” about bankers, and the colorful life of the creator of the Phillips Curve. 

The interview has been edited for clarity and length.

What are some of the lessons from history for today’s policy makers?

There are numerous episodes in history of fiscal overshoot, too much demand stimulus. One is with Lyndon Johnson and the Vietnam War. Another one is Richard Nixon over-stimulating the economy quite deliberately to get elected. There was too much fiscal stimulus again this time. But the quantitative dimension in causing the inflation we’re dealing with is greatly exaggerated. It caused some but not close to most.

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We’ve also had food shocks and oil shocks that both quantitatively and qualitatively resemble things that happened back in the ‘70s and ‘80s. In the book I tell the story: When these first started happening, in ‘72, ‘73, ‘74, the Federal Reserve — like central banks around the world — was kind of confused. This was something new. You were not supposed to get weak economies or even recessions with rising inflation. They learned from that. By the time they got later into that period they understood, for example, that the impact of food and energy prices on overall inflation would naturally dissipate over time. 

You’ll remember Team Transitory. A reason for the existence of Team Transitory was looking back on the ‘70s and ‘80’s, when there were these spikes in food and energy prices and they went away. They didn’t go away because of monetary policy. They just went away. Most of us on Team Transitory — and Team Transitory included the Federal Reserve, as you know — thought today’s shocks wouldn’t last. We’re not looking great these days because transitory has turned out to be a lot longer than we imagined. We’ll be right eventually but were really wrong in calling it transitory. 

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In the book, you call former Fed Chair Paul Volcker “the Babe Ruth of central banking” for the role he played in conquering inflation. Who else would you put in the Fed Hall of Fame for monetary policy? 

If you put aside regulatory issues — which is where he fell down very, very badly — and only look at monetary policy, Alan Greenspan deserves to be up there. He was a fabulous macro manager. He unfortunately had a blind spot which Paul Volcker did not, about laissez fairy tales about bankers. Volcker understood them much better than Greenspan. When Greenspan testified to Congress he was shocked that they could be so lax in their own risk management. Volcker would not have been shocked. If you take that away  — which in a full appraisal of Alan Greenspan as leader of the Fed you shouldn’t take away — but if you just concentrate on monetary policy, I think he was superb. 

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You sprinkle the book with short profiles of influential policy makers and academics. One of the more interesting was A.W. “Bill” Phillips, the originator of the Phillips Curve that links employment, wages and inflation. Tell us a bit about him. 

This guy was as inter-disciplinary as you can be. He was a practical engineer as a young man, with a wrench in his hand, and then later in his life an academic who took those ideas to economics and in particular to Keynesian economics. He had a very mechanical view of the macro economy. He built this machine where water flowed through clear plastic tubes, like income and expenditure in the economy. People spend money that becomes income to other people, and they spend money that becomes income to other people, and so on. The machine is now at the Reserve Bank of New Zealand. 

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He also had a colorful history. He won a Member of the Order of the British Empire award for bravery handling a machine gun during World War II. He was captured by the Japanese and became a prisoner of war, during which time, among other things, he learned Chinese from his fellow prisoners. 

Some critics charge that Keynesian economics is just all about the government spending more money and that it’s inherently inflationary. What’s your response? 

If you go back to the 1930s when Keynes wrote the General Theory the problem was enormous slack in the economy, depression. So it was natural for him to focus on stimulating the economy. But as Keynesian economics developed and was modernized, the theory is basically symmetric. The same weapons you use to fight depression are used in the opposite direction to fight inflation. 

That was not a problem Keynes worried about in 1936, but is a problem we’ve had occasions to worry about at intervals since then, including right now. Keynesianism got a bad rap as being inherently inflationary, that it was all about pushing the economy faster, which it isn’t always.