America’s Economic Riddle

>> Bill Whalen: It's Wednesday, April 17, 2024, and welcome back to Matters of Policy and Politics, a Hoover Institution podcast devoted to governance and balance of power here in America and around the globe. I'm Bill Whelan. I'm the Hoover Institution's Virginia Hobbes Carpenter distinguished policy fellow in journalism. I'm not the only Hoover fellow who's dabbling in podcasting these days.

But I suggest you go to our website, which is hoover.org, click on the tab at the top of the homepage it says commentary. Head over to where it says multimedia. And up will pop a listing of audio podcasts, including this one at the very top of the list.

I think we're at the top of the list because I endeavor to get the best and the brightest that the Hoover Institution has to offer, today's guest being no exception. My guest today is Mickey Levy. Mickey Levy is a Hoover Institution visiting scholar and for the past 40 years, a member and director of the Shadow Open Market Committee.

A renowned micro economist and former chief economist of Bank of America. Doctor Levy's research focuses on monetary and fiscal policies and how they affect global economic and financial performance. In addition to his work as an independent consultant, he also testifies regularly before the US Congress on monetary and fiscal policies, banking and financial regulation, and trends in global economics and trade.

Mickey Levy's at Hoover as he and his fellow economists prepare for next week's monetary conference. This is May 2nd and 3rd here at the Stanford campus. It's an annual tradition of Oris, a spring tradition. This is the 14th such conference I believe the Hoover Institution has led on this topic.

Mickey, thanks for coming on the podcast.

>> Mickey D. Levy: Absolutely my pleasure.

>> Bill Whalen: So is that monetary conference like Woodstock for your economists? Do you guys behave and sit into your conference, or do you go out hiking and enjoy all that northern California has to offer?

>> Mickey D. Levy: No, it's all substance.

We begin with a dinner and then a full day of paper presentations and panels with focuses on specific topics to do with monetary policy, both US and international.

>> Bill Whalen: Okay, I wanna get more into that toward the end of the podcast because I'm very interested in particular this year as to tone and tenor.

I've said it in the past couple months, and I'm always curious as to what you guys have to say vis a vis federal reserve. But today, Mickey, I thought we would talk in sort of general terms about the economy. Keep in mind, you're a very bright economist talking to a political hack here, so you're gonna have to dumb it down for me a little bit.

But I want you, since I'm at all times fascinated with politics, I want you to kind of unravel the mystery of Joe Biden and the economy right now in this regard, Mickey. The president of the United States is doing something unusual this week. He is campaigning not one, not two, but three straight days in the great state of Pennsylvania.

He likes to go to Pennsylvania. It's next door to Delaware, where he likes to go on weekends. Pennsylvania happens to be very important to his reelection chances. What's curious to me, Mickey, though, is the message that he is selling to Pennsylvanians right now. First of all, it's in large part middle class warfare, he says about Donald Trump, he wants to double down on trickle down.

There's populism. Biden is talking about what he calls kitchen table Scranton versus Mar a Lago. Then when it comes to economics, Mickey, here's what Biden is talking about. He has called for an increase in taxes on billionaires. He has vowed that he won't increase taxes on Americans earning less than $400,000 annually.

He touches a bit on his record. He touts efforts to bolster the Affordable Care Act, lower the cost of prescription drugs. But Mickey, there's a lot that he is not mentioning. He is not talking about unemployment, for example, which is back to pre-pandemic levels. He is not talking about the stock market being at record highs.

And so this has me confused as to what exactly the message is and what headwinds his presidents encounter. What say you?

>> Mickey D. Levy: Well, Bill, its really quite interesting. The economy in the US has been quite resilient. And the unemployment rate is very low, below estimates of long run full employment.

And employment keeps growing month after month and the economy is quite resilient. But that resonated with the electorate. And Biden has not shown very well in the polls, despite the performance of inflation. And I think that has to do in part with the residual of very high inflation.

So if we think about it, the Fed and financial markets are doing high fives, that inflation has come way down, but are much, much higher than they had been before the pandemic. And if we think about the middle class and lower income earners, that is the prime sector of the electorate, they are really getting harmed by dramatic increases in the prices of the goods that hit them the hardest.

That is the cost of renting, cost of home ownership, energy costs, food costs, simple things like going to the grocery store. And so it's the price levels that are creating the sticker shock and people feel like they're falling behind. So in recent months, President Biden on the campaign trail has touted the economy and he's also touted industrial policies, the Chips Act, all of the infrastructure spending that is creating jobs and the like, but it hasn't resonated with the public.

And so he's spending time in Pennsylvania, where he's also getting poor marks on being anti-oil drilling and fracking, which is a big industry, Pennsylvania. And so he shifted gears and back to the old beating up on Donald Trump. He's trying that. So it's very, very interesting what's going on.

Bill, let me just conclude and say, if this were a typical presidential election season, and I showed you on the unemployment rate, the growth in employment and disposable income and the relatively low rate of inflation. You would say, it should be a slam dunk for Biden, particularly because he's an incumbent.

But that's not the case.

>> Bill Whalen: Now, you're right. So let me point you to two polls, Mickey. First of all, there's a survey out this week by the Financial Times, University of Michigan's Ross School of Business. It gave Biden a approval rating overall of 43%, but on the economy gets 41%.

So he's below approval, but there's room for growth there. The number that caught my eye, though, is a poll out in March by the Economist YouGov, which showed that 22% of voters identify inflation and prices as the most important issue, 7% cite jobs in the economy. So here's maybe the answer as to why he's not talking about unemployment.

Voters are just more focused on the cost of things than they are those unemployment numbers.

>> Mickey D. Levy: I think that's right. Again, the financial markets are doing high fives over the low inflation, although not this week, where you see in response to the recent backup in inflation, your interest rates going up.

But let me add also that people are also very concerned, Bill, about the housing market. And we've had this housing prices since 2022. The cashier or home price index is up over 40%. And now you see mortgage rates increasing. So many people have been unable to buy a house.

Supply of housing, existing homes is very low because those who did buy a home or refinance when rates were so low in supply. And so you have this frustration on the part of the electorate. And now, let me add one other thing that to emphasize a point you made at the outset.

And that is, if we look at the campaigns of President Biden and Donald Trump, the campaign, his platform includes very aggressive increases in spending and higher taxes on higher income people. And that's his agenda. It's a very traditional democratic economic platform, seemingly in disregard to the current problem of high deficits and mounting debt.

 

>> Bill Whalen: Right.

>> Mickey D. Levy: Okay, on the other hand, Donald Trump, one of the key components of his platform is sizable increases in tariffs. And not just tariffs on China, but tariffs on all imported goods. And that would come at a time when the economy is much more fragile than globally than when he imposed tariffs in 18.

So one can find faults from an economic perspective in both of their platforms. But Biden is really struggling despite the ongoing good economic news.

>> Bill Whalen: Okay, but why this economy, though? You could call it resilient, I think that's a word that you like to use here. It's a resilient economy.

Why is it resilient, Mickey, when interest rates are above inflation at their highest levels since before the financial crisis?

>> Mickey D. Levy: Well, the simple answer to that is the economy is resilient for at least two reasons. One is, while interest rates are well above inflation, the neutral or natural rate of interest has gone up.

Reflecting a pickup in productivity gains and potential growth while the Fed has raised rates above inflation. It's not restrictive because the natural rate of interest has gone up to reflect these positive factors. That's one reason. The other reason is it's amazing what's going on. In productivity, it's picked up, the pace of innovation continues in the US.

The innovations in a wide array of industries is generations ahead of the rest of the world. AI, medical technology, just absolutely everything. You also see a decided pickup in new business formation. So the US economy is really percolating along. And then also, we have an increase in the labor force, in part due to new immigrants.

But at the same time, during 2020 to 2022 or so, there was an insufficient supply of labor and businesses were unable to hire all they needed. Situation where businesses need to hire to produce more in order to meet product demand. So it's a very positive cycle. So it's very interesting to put the US economic strength into perspective because Europe, the UK, Japan are all struggling.

And the US is not just resilient, but it's a potential at the same time. Many economists, like myself, have increased their perception of the sustainable potential growth of the economy.

>> Bill Whalen: Let's spend a minute talking about consumer spending. One would assume that more money is being spent if more people are working and more people are making money and have money in their pockets.

Is it as simple as that, Mickey, or something else is going on here? And how would you judge consumer spending just anecdotally if you were a political hack like me? Would you drive around neighborhoods and see if people have new cars in their driveways or find out if people are going on vacations?

How would you measure it?

>> Mickey D. Levy: I measure it by the official data. And what you see is retail sales are rising. But then, of course, when we look at total consumption, which is about two-thirds, almost two-thirds of consumption is consumption of services. And so what you see is consumers are spending.

Now, before I come back to the fundamentals, what do I look at anecdotally? Restaurants are packed, airlines are packed. You drive by shopping centers and cars. And so people are spending money. So that's the anecdote. But let me get back to the fundamentals underlying consumer spending. Traditionally, the number one factor driving consumption is disposable income in real terms.

That is real purchasing power. And that tends to be driven by hours worked and wages. So what you've seen is a persistent increase in employment month after month. That builds confidence, that leads people to spend. And wages are going up a little bit faster than inflation. So that's the fundamental.

Now, you have higher real interest rates. And if I had to identify one surprising feature about is debt finance consumption. 80% of new autos tend to be financed. And the rates on those are over 7%, yet auto sales are doing well. Now, let me get to another factor that's driving consumption, and that is household net worth.

So if we consider household net worth net of all debt, that includes the value of homes, stocks, bonds, monies in IRAs and Keoghs, savings. The numbers are staggering, Bill. Okay, so let me toss out a number here. December, that's the latest number we have. 155 trillion in household net worth, and it's gone up 11% in the last year.

And that increases the propensity to spend. Now, digging in a little deeper on this, the US Bureau of the Census conducts surveys. And their latest survey from 2022 shows that, yes, wealth is unevenly distributed, but it isn't all Jeff Bezos and Bill Gates and Elon Musk. In fact, if you look at the 75th percentile household in 2022, their household net worth was about $650,000.

If you look at the 90th percentile household, the household net worth, once again, net of all debt, was 1.6 million presumably that's increased a lot in the last two years with the increase in stock market. And another interesting piece of data here is nearly half of that 155 trillion is held by people who are over 70 years old.

That shouldn't be a surprise. But that money is trickling into the economy. It not only increases the propensity to spend out of disposable income because people feel wealthier, borrow against the value in their house. But how many of those people who are over 60 or 70 whose child graduates from college, gets their first job and says, hey, could you help me with the down payment on my mortgage?

That's prevalent. A couple years later, they have kids, could you help pay for the grandchild's education? And then about $13 trillion, and these are big numbers are in IRS and KYOS, where people over 72 have required minimum withdrawals. So the high wealth is trickling into the economy. So once again, we're a very wealthy nation, and you see people spending.

The number again is employment disposable income. As long as people spend and businesses see product demand growing, they hire. So we're on this very positive. And so let me conclude by saying, and I know this is a long-winded answer, we have this positive cycle, but when I look at what might upset the you don't see excessive inventories held by businesses.

You don't see any significant imbalances in the domestic economy. That's really going to sidetrack things here. So it's quite positive.

>> Bill Whalen: I want to go back to the, those people in their seventies who are sitting on wealth right now, who are doing well. Do we have any evidence, Mickey, as to what they're doing vis-à-vis their housing situation?

Because I'm curious at all times. Or in other words, it's a challenge, obviously, for a growing family to buy a larger house because of interest rates. But what about the family that's higher up in the pyramid? Are they selling their house and downsizing, or do they wanna stay put right now with interest rates where they are?

 

>> Mickey D. Levy: Well, on average, I think people are staying put. A lot of people, regardless of age, who either bought when mortgage rates were really, really low, or there were tens of millions of households during that period who refinanced their homes. They want to stay put because to move, they would have to give up that mortgage and get a new mortgage at a much higher rate.

So you have a lot of people staying put. And once again, capital markets are very efficient. Many people can borrow against the appreciation of their house to finance consumption. But once again, Bill, unlike the period before the financial crisis, loan to home value ratios are quite low. And finances, they're in pretty good shape.

 

>> Bill Whalen: Okay, more people working Mickey begs the question of productivity. More time in the workplace, are people producing more? Now, you contend that productivity gains have picked up. I'm curious as to why you've come to the conclusion of what might be driving that.

>> Mickey D. Levy: Bill, that's a great question, because the aggregate productivity data that are published federal reserve, they bounce around a lot, and they're actually measured as output in the private sector.

They take out the government output in the private sector divided by aggregate hours works. And those data are too aggregate, and they bounced around a lot as the composition of employment has changed, as the lower productivity service employment has increased so much. My direct answer to your question is, yes, you've seen those numbers pick up, but I don't think they're particularly reliable.

My assessment of the pickup in productivity growth is based on, and it may be proven wrong, but it's based on mounting anecdotal evidence. And that mounting anecdotal evidence is by how quickly technological innovations are being implemented into commerce in so many different industries and social activities, not just AI, but advanced computing, the medical industry, just every industry you can think of, you see adding to productivity.

And what's interesting about this, let me just make two points. One is some recent studies, including Stanford professor Eric Berne Jolson has done microanalysis, which has shown that the biggest productivity gains have lower skill level people and younger people who are just beginning. And so this could be very different than historic technological innovations that in the past primarily benefited high-skilled people.

So that's very interesting. The other observation I would make is when we had a surge in productivity in the 1990s, I remember Fed Chair Alan Greenspan identified it early on, and his assessment of that was once again based on anecdotal evidence rather than the official data. So let me put this together.

If, in fact productivity is higher, that is not just that the gains in productivity have increased and will be sustained. That means the expected returns to capital have increased. And that is what is pushing up the natural rate of interest. And so when your resilient when real interest rates are high, it's because the natural rate of interest is higher, reflecting, in part, these productivity gains.

So this is a very exciting time to be an economist and an observer of the economy.

>> Bill Whalen: Okay, I want to talk about inflation, Mickey. And when I think of inflation, I go down a rabbit hole. I'm a child of the 70s, and I can show you a whole bucket of 70s political goods I have.

I have a Spiro Agnew watch somewhere around here. I have Nixon and McGovern buttons. And I have a Whip Inflation Now button as well. Remember WIN as well? Offbeat question, though. Why does anybody talk about the misery index anymore? Growing up in the 70s, that's all I heard.

Misery index. Misery index, which is what? Employment inflation. But I don't see it tossed around in stories anymore as the misery index become passé?

>> Mickey D. Levy: President Reagan, when he was campaigning for president the late 70s and 1980, touted the misery index, which was the sum of the unemployment rate and inflation.

Back then you had Because of stag, combination of a very high rate of inflation and very high unemployment rates. The misery index was sky high and it really captured the sentiment of the day. Now it's far different. The unemployment rate is very, very low, below 4%. And inflation, the current measure, has come way down from its peak in 2022.

The misery index is low. But earlier, the very high level of prices is resonating quite negatively. So the misery index doesn't hold, right.

>> Bill Whalen: So this is the challenge for Biden, Mickey, and that he could go out and say, look, statistically, the misery index is better than it was in 1983 or just 1979.

Whatever numbers you can throw off the top of his head, but voters aren't going to feel it because again, they're stuck on inflation and price. Let's talk about that. Now, you wrote a paper not too long ago and the title was disinflation, but higher prices. Can you explain what that headline means?

Disinflation, but higher prices?

>> Mickey D. Levy: Well, sure. So inflation is a persistent change in the general price level, whereas prices are the current level of prices. So right now we're in this period since inflation period so you can call it disinflation. That's good. So the Fed and financial markets are quite pleased about that.

Prices are much higher. So if you actually look at the consumer price index on aggregate, it's about 18% higher than it was just before the pandemic. And then, Bill, if you look at CPI that reflected items that people spend most of their money on, particularly the middle and lower income people, prices are way higher than they were before the pandemic.

Energy prices, filling your car with gas, home heating oil, getting on an airplane, where the highest cost, the highest price item, the cost of shelter, whether you're a homeowner facing much higher homeowners insurance or you're a renter, where rents have gone up, reflecting higher home prices. The cost of food, I don't care where you are on the income scale, you have to see sticker shock to eat, prices of restaurants have gone up a lot, not just less so because of the price of food, but labor costs.

And let me add one other point that's interesting here. The one large component of the CPI where price increases have lagged behind and haven't gone up that much is medical expense. And this is what quite striking. And I think one of the reasons why the aggregate price index for medical costs haven't gone up is the Biden administration is trying to squeeze reimbursement schedules for doctors and medical providers.

And this is showing up as lower increases in medical costs. But what it's doing is squeezing the margins of medical providers and causing a lot of problems in that industry. So overall, once again, disinflation, but higher prices. And this is one of the critical economic elements that's describing the landscape of the election season.

 

>> Bill Whalen: Now, two entities with higher prices, Mickey, would be the price of gasoline, and I say this is Californian. Anytime somebody comes to visit me from another state, the first thing their eyes bug out is when they see the price of a gallon gasoline here, cuz usually it's a couple dollars more from where they're coming from and the price of food.

Now, some politicians, Mickey, have decided this is a good opportunist scapegoat. Here in California, for example, we've had legislation accusing big oil of price gouging. You have Elizabeth Warren, the president of the United States, fascinated with how many potato chips are in a bag right now. In other words, blaming corporations and evil corporations are manipulating the public right now.

They're screwing you out of your goods. Where do you go along with this?

>> Mickey D. Levy: It's just political blather. It is silliness. But people, because they focus on anecdotal evidence, they like to blame somebody, and so they always blame business. The bottom line is inflation is generated when you have excess demand relative to productive capacity.

So if you look at the bout of inflation we had coming out of the pandemic, that was generated by excess, driven by the government's extra 5 trillion in deficit spending, writing checks to people and the Fed keeping rates at zero and monetizing the debt by buying half of the new government bonds, that increased demand dramatically.

And at the same time, you had supply constraints and bottlenecks both in the US and globally. So the Fed, of course, which has this practice of not accepting any blame and blaming other people, basically said, the high inflation is due to supply constraints in their transitory. Well, that was very odd.

They would say that even though they said it during a period when there was the fastest growth in aggregate demand. So now you've had the Fed has raised rates and people have spent a good portion of the checks they received from the government, and aggregate demand slowed down.

But, Bill, in the last year, nominal GDP, current dollar spending in the economy still growing over 5%, which is still healthy demand. And so you still have the economy percolating along, generating sufficient product demand so that inflation is not gonna come back to 2% right away. And I think we're stuck here around two and three quarters, so they blame it on businesses.

 

>> Bill Whalen: Right.

>> Mickey D. Levy: They blame it on whatever is that's just pure silliness. Now, is there quote unquote, shrinkage? Do you see, used to buy a jar of something and it had 16oz and now it has 12 or 13? Yes, that's how businesses respond to their higher production costs and they try to maintain their margins.

That's part of inflation. But it is not generated by business and it is not fueled by business greediness. It's generated by excess demand.

>> Bill Whalen: Mickey, I'm thinking of the young man or woman who's graduated from a very elite institution in America and they've dreamed about working in Washington all their life and they land a job with Senator Warren.

There may be a legislative aide or a legislative correspondent and you know what their job is? It's not solving the world's problems or job, Mickey, is they sit at their desk and they have to count chips every day at a bank.

>> Mickey D. Levy: Well, look. Let's just put it this way.

Young people who go to Washington, who work for politicians, politicians are driven by how they can look good for the next election, and so they have their perspective. And whether you're on the far left or far right, you can find anecdotal evidence seemingly supporting your frame of mind and your point of view.

 

>> Bill Whalen: Well put, Mickey, I want to turn your attention to something that our colleague John Cochran wrote in his grumpy economist blog, not recently, and he wrote the following, quote. Germany stopped a hyperinflation in a month. As for the United States, John writes, quote, a credible announcement of spending, tax and growth reforms that put the budget on a sustainable track would do the job.

Scaling back the Inflation Reduction act, the Chips act, student debt, river, and recognition of inflation would help a lot more than complaining about how many potato chips are in a bag. Even just saying we recognize that's needed would help.

>> Mickey D. Levy: Well, once again, John has hit the issue properly on the head and we have excess demand in the economy, but part of the inflation process is inflationary expectations.

And the way to reduce inflationary expectations is not just the Fed raising rates and cutting back the size of its balance sheet, but its fiscal policy. And let's be honest here, we have high and persistent deficits that we cant grow our way out of and thats adding to the debt.

And to be an economist, if you just simply look at, as an observer reading the newspaper, watching the evening news, you get the clear impression that the fiscal policymakers in our country, in Congress. The budget process is totally dysfunctional, and the prospects of meaningful deficit reduction are look at the composition of the persistent deficits.

The vast, vast majority of it, if not all of it, is attributable to increased spending on what we call the entitlement programs, the Social Security, Medicare, Medicaid, the SNAP program and the like. By the way, the reason why these are called entitlements, not require congressional authorization every year, they are basically entitled every year.

And the compounding of all of these entitlement programs that are all either directly indexed for inflation or indirectly indexed for higher prices. The compounding is catching up with us, and I think this is with the public. So I agree with John Cochran. If Congress were to pass a meaningful deficit cutting package, that could be fair.

That would go a long way toward restoring sensibility in the government's budget and would really help on the inflationary expectation front. But of course, don't count on it in the 2024 an election year. And then once again, if you look at President Biden's economic platform, aggressive spending increases and higher taxes on higher income people, that doesn't do it.

And the Trump platform, exception of his proposal for significant increases in tariffs, it has a bunch of question marks. So you don't get confidence in the government's willingness to get a grip on the budget.

>> Bill Whalen: Yeah, one thing I'd point to, Mickey, is that whoever wins this election is immediately a lame duck president because Biden would be serving a second straight term, Trump would be serving a second term.

Now, these gentlemen are what we would call reformers, you're not gonna see anything really dramatically done to entitlement or just government programs. This, to me, is an issue for whoever comes in in 2029, but let's segue to monetary policy in the monetary conference. Looked up some past conferences, Mickey, the title in 2022 was how monetary policy got behind the curve and how to get back, the title in 2023 was getting back on track.

Question to you, in 2024, are we back on track, and what does being back on track necessarily mean?

>> Mickey D. Levy: Getting back on track means having monetary policy be appropriately consistent with getting inflation back to 2%, which is the best foundation for sustained economic expansion. And so, of course, in 2020 through 2022, the Fed was way off track, and not just the Fed, the Bank of England, the European bank, way, way off track.

And now inflation is coming down still above the Fed's 2%, and the Fed has acknowledged this now, and so are we back on track? Well, we're kind of heading in the right direction, but we're not back on track yet. And the issue is, well, there are many issues, but one issue is, is the Fed to move to monetary restrictiveness if employment should slow a lot?

And there, that's a big question mark, a big, big question mark, because historically, the Fed has responded very quickly to signs of weakness in employment markets. So right now, employment's been strong, the Fed is saying, no, we now, which is the wise thing to say, but should we see some crackdown in employment, then the Fed will be put to the test.

Bill, let me add that there's a panel at the upcoming Hoover monetary conference on the Fed's upcoming strategic review. And I'm joining with plasser, the former president of the Federal Reserve bank of Cleveland, on that panel we're writing a paper on the Fed's upcoming strategic review. And this is critically important because the Fed in 2020, after a year and a half of a strategic review, dramatically changed its strategic framework, favoring higher inflation, basically.

And expanding its mandate maximum inclusive employment, which is way beyond the capabilities of the Fed, and it contributed to the high inflation. And right now, a significant concern is, okay, now that inflation has come down, what does the Fed do next? And the Fed historically has coveted its approach to the conduct of monetary policy, even though there are simple rules that they could have used that would have saved them from making major mistakes.

And so when you get beyond the current conduct of monetary policy and the inflation, the economy, you have this underlying major issue. What should be the Fed's proper work for conducting monetary policy in the way that it best helps the economy?

>> Bill Whalen: Two questions for you, Mickey. One, do you think we will see at least one, if not multiple, cuts in the interest rates?

This is assuming inflation continues to go down. So do you think we'll see a rate reduction this year? And then secondly, let's go to the bigger picture and just grading the Federal Reserve on its monetary policy. So the question to you, will you see cuts this year, yes or no?

 

>> Mickey D. Levy: But I think it'll be later in the year. But that yes is absolutely conditional on inflation coming down a bit further. And in the last two months it backed up a bit. And it's also conditional on employment gains slowing down. So it's a conditional yes, but I do think they will cut, but it'll be later in the year.

 

>> Bill Whalen: And what if inflation goes up?

>> Mickey D. Levy: Boy, great question. I don't think the Fed would raise rates here because their perspective, when I say their perspective. Following the last FOMC meeting, the vast majority of the FOMC members have been out giving speeches and all of them have characterized monetary policy now as the rate is significantly above inflation.

I don't think they would raise rates. I think if inflation ticked up a touch, they would just say, we're gonna hold pat here and stay where we are because we are restrictive. Once again, the fact that the natural rate of interest is probably higher than the Fed thinks calls into question how restrictive the Fed really is.

How could you say you're restrictive if the economy is growing faster than your estimated potential? But so I think a tick up in inflation would keep the Fed on hold, which is in the last month, we've seen this expectation is being reflected in higher bond yields. I think it would take a significant increase in inflation for the Fed to raise rates here.

Probably not. Now, as for-

>> Bill Whalen: Grade the Fed, you can give them A to F, 1 to 10, 0 to 100, whatever meter you wanna do.

>> Mickey D. Levy: 2020 to through the spring of 2022, when they started raising interest rates when inflation was high, I give them very poor grades.

 

>> Bill Whalen: Like a D?

>> Mickey D. Levy: A D, okay, give them an F. In 2020 remarks, they finally acknowledged they were so far behind and they were quite aggressive in raising rates. Now, I give the Fed. Okay, marks, give them a b mark because they are properly stating that they cannot lower rates now.

And most importantly, I'll give them good marks for saying we're committed to lowering our 2% target. Where I would downgrade the Fed a little bit is for two reasons. One is they don't have a good framework, a viable, long run framework for conducting policy, and we'll see what their strategic review comes up with.

The second reason why I would downgrade the Fed is in their strategic plan they have in place now that they put in place in 2020. They argued, we want higher inflation as a makeup strategy for the sub 2% inflation that existed prior to the pandemic. But in their strategic plan, they didn't include any language about a makeup strategy above 2%.

And now we'll think about the following. The inflation that we've incurred since 2020 has been more than double the makeup of the sub 2% inflation. Yet now the Fed says, our goal is 2% inflation. And so basically what they're telling the public is that those dramatic increases in prices, our strategy is to keep those prices high.

 

>> Bill Whalen: Mickey, you've raised the Fed from an F to a B. That's progress. What would it take for the Fed, in your estimation, to get an A?

>> Mickey D. Levy: At least two things. First, get inflation down to 2%, even if the economy slows a lot in the process of doing so.

And secondly, put in place a strategic plan that is balanced around 2% inflation without all the overly complex, flexible average inflation targeting they have now. And secondly, to acknowledge their goal of maximum inclusive inflation is more of an aspiration we would all like. But it's really beyond the capabilities of the Fed.

It has to do with fiscal policy, education policy, tax policy, regulatory policies, and like. And thirdly, I would definitely give the Fed an a if they would acknowledge that discretionary approach to conducting monetary policy has resulted in some bad judgment that has been costly, and that they were going to not go to a rules based policy strictly as John Taylor would advocate.

But they would at least say, we're going to pay a lot more attention to estimates as a guideline for us conducting thought policies in a way to help us avoid making major mistakes going forward.

>> Bill Whalen: Final question, Mickey. There is good news for American travelers this summer. Maybe not good news.

When they bought their airfare, that was probably a punch in the gut. But here's the good news, Mickey. If you hop on an airplane and you go to London this year, if you hop on an airplane and go to the European continent, if you go over to Japan, what's the good news?

Your dollar is going a long way versus the pound. Maybe not the glory days of the 80s when people would travel over to London with two suitcases and fill up the empty one with everything from Harrods they could get their hands on. But still, the dollar is doing well against the pound, it's doing well against the euro.

It's doing well against the yen. What does this mean that the dollar is doing well?

>> Mickey D. Levy: Bill, that's a great question. The strength of the dollar is consistent with the higher real interest rates that in relative terms, the us economy is way outperforming the economies in the UK, Europe and Japan, all of whom are really struggling with.

And the US has higher productivity prospects and much higher potential growth prospects than in those countries. And reflecting the higher expected rates of return on capital, and not just capital in general, but higher expected rates of return on capital denominated relative to capital denominated in pounds or euros or yen, you have higher, a stronger dollar.

Okay, and that's just reflecting the relative outperformance of the US economy and expected continued outperformance. And so yes, it's good for us going abroad, but it raises US unit labor costs of production relative to overseas. So, but it's definitely a positive.

>> Bill Whalen: Okay, Mickey, we're gonna leave it there.

Hey, on a personal note, I'd like to thank you for coming to California. You and your lovely wife have set up shop here. You've been here for a couple weeks as somebody who pays way too much in taxes and a very complicated economy. We have a very high unemployment rate here in California.

Get out there, spend money, push our economy. Mickey, thank you very much. Thanks. It's been a pleasure and good luck with the monetary conference. I look forward to it. You've been listening to Matters of Policy and Politics, the Hoover Institution podcast devoted to governance and balance of power here in America and around the globe.

If you've been enjoying this podcast, please don't forget to rate, review, and subscribe to our show. The Hoover Institution has X, Instagram and feeds. Our ex handle is @hooverinst. I mentioned our website at the beginning of the show. That is hoover.org. I recommend that you go there and sign up for the Hoover Daily Report, which keeps you updated on what Mickey Levy and his Hoover Institution colleagues are up to.

That's emailed to you weekdays. For the Hoover Institution, this is Bill Whalen. We'll be back soon with a new installment of Matters of Policy and Politics. Until then, take care. Thanks for listening.

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