26th Annual Financial Markets Conference Transcript: Keynote Address: Charles Goodhart and Manoj Pradhan - May 10, 2022

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Keynote Address: Charles Goodhart and Manoj Pradhan

The authors' "Inflation and the Policy Response to Supply Shocks" contends that the low inflation rate observed in recent decades largely resulted from a large increase in labor supply, mainly due to China's integration into global markets. However, this growing supply is reversing almost everywhere except Africa. This reversal is likely to lead to slower growth, and potentially stagflation, in the medium run.

Transcript

Raphael Bostic: Good morning. I hope that you enjoyed the dinner conversation last night. I thought it was very provocative. We had great discussions at our table, and they carried on well into the evening. I actually had conversations with many of you in the room, so it was a good time. I really enjoyed that.

I hope you guys also enjoyed the panels that we had yesterday. They were also quite interesting. They got me thinking a lot about the green investment space, as well as central bank digital currencies, and I am really looking forward to today. We have a real treat. We are joined by professor Charles Goodhart and Manoj Pradhan for what I think will be a really interesting and lively discussion on some of the fundamental forces that are shaping our world today and will undoubtedly be important for years to come.

Let me first give you brief bios of our speakers for today. Charles Goodhart, who is on the screen there...I think you guys can see him on the plasma screen...he is the emeritus professor of banking and finance at the London School of Economics after nearly 20 years as LSE's Norman Sosnow Chair of Banking and Finance. He's also the founder of the financial markets group at LSE. Before that, he was a monetary economist at the Bank of England for 17 years. More recently, he was an economic consultant to Morgan Stanley, and he is a fellow of the British Academy. In 1997, he was awarded the Commander of the Most Excellent Order of the British Empire for services to monetary economics.

Charles, it's really good to have you. He's here, as I mentioned, on livestream. Welcome from across the Atlantic. Good to have you with us this morning.

On stage, we have Manoj Pradhan. Dr. Pradhan is the founder of the independent macroeconomic research firm, Talking Heads Macroeconomics, which is based in London. Did you get that off the band? Yes, the Talking Heads were some of my favorites, so that's really good.

He previously led the global economics team as a managing director at Morgan Stanley and taught at George Washington University and the State University of New York. Welcome, Manoj, it's really good to have you. We're pleased and honored to have both of you with us today.

These guys in 2020 wrote an ambitious book that was called The Great Demographic Reversal: Aging Societies, Waning Inequality, and an Inflation Revival. It offers predictions for some of the most important trends that are influencing our society, so this is a really interesting topic to be speaking on...issues around inflation, which we talk about a lot these days, but also issues around demographics and implications for inequality that I think are also quite important. We all are having increasing conversations on those topics as well, so I am really excited for the presentation and the conversation. We will take your questions on all of these issues and whatever else you'd like to talk about after they've each made some remarks. Let's get right to it. Professor Goodhart, Charles, the floor is yours.

Charles Goodhart: Thank you very much. I wish I could have been with you in person this morning, but health and age considerations have precluded that. As you said, what we bring to the table, what is particularly new in our work, is that we focus much more on two aspects. First of all, we look at global considerations rather than national considerations. In our book, there are chapters on Japan and China, but there are no chapters on the United States, there are no chapters on the United Kingdom, and there are no chapters on the Euro area.

Secondly, we are concerned much more with supply considerations than most other researchers who focus much more on demand factors. With that as the background, we're going to take you through three periods: the recent disinflationary past, and how to interpret it, the current spike in inflation, and how we think you ought to handle it, and the medium- and longer-term future.

I rather apologize to those who've already read our book, but I'm going to take you through a few slides which are taken directly from our book, which I think are particularly relevant. The first of these slides is the working age population. Here, on the left-hand side, the complete blue line shows the rate of growth of the working age population in the developed economies of North America, Europe, Australasia, from the beginning of 1980 through to the future. You can see the future is growing, but it's growing fairly slowly.

What happened during the decades from 1980, the three subsequent decades, was that China and Eastern Europe, after the breakup of the USSR, entered the world's trading system. China is the most populous country in the world, and that meant that there was a huge increase in the availability of labor to anybody who could shift their production from the high-wage economies to the low-wage economies, and they did so in huge quantities. China became the workshop of the world, and manufacturing production equally declined really pretty sharply in the United States, and in Europe, and indeed in the United Kingdom, in some large part as a result.

The increase in the working age population started to change around the year 2010. As you can see from the right-hand picture, it's now going to decline really very sharply, though the decline will be far less if the developed economies can take advantage of the available workforce in Africa, which is the only area, alongside bits of India and maybe bits of southern America, where the working age population will be rising in future years.

What this has meant, as we move on to the next slide, is that the dependency ratios really began to fall quite sharply, in particular as the fertility rate in women declined very sharply after the baby boom following World War II. You've got a decline in dependency ratios as the number and proportion of young in our economy declined sharply before the proportion of old began to rise, as shown in this particular next slide.

The decline in the fertility rate, and indeed, in recent years, the rise in the age of marriage and having the first child, interacting with the availability of consumer durables, refrigerators, freezers, washing machines of various kinds, and so on, released half the population, i.e., the women, from doing housework, which was not included in gross domestic product, to becoming actual workers in the economy, as shown in the next slide.

That meant that there were huge disinflationary forces at work. The shift of manufacturing production to the low-wage economies had three effects on disinflation. First, goods prices were cheaper. Secondly, it broke the power of labor unions in the manufacturing sectors in developed economies. Thirdly, it shifted labor from the manufacturing to the service sectors, where labor was much more separated and with far less in the way of bargaining power and unionization.

During the years from 1980 to 2010, the effective power of labor, the bargaining power of labor, actually collapsed. That was a significant tendency towards disinflation. Moreover, with the dependency ratio improving, an increase in workers tends to be disinflationary because you pay workers less than the value of what you think they can produce. What's more, workers don't spend all their wages. They have to put some of it by for their retirement. While on the other hand, the dependents, the young and the old, consume, but on the whole they don't produce, and therefore they are by definition inflationary.

What we've got, starting in 2010, was a dramatic reversal in the previous demographic shift. Of course, the effect on labor wages was going to be very slow because the labor bargaining power had collapsed and the momentum for maintaining wages low remained very strong. When we wrote our book, before the pandemic struck...we basically wrote it in 2019...we didn't really know within plus or minus about five or ten years when the shift from a disinflationary back to a more inflationary structure of the world would take place. Then COVID hit, and for a variety of reasons we thought that this would bring the change from a disinflationary to a more inflationary system forward in time. Can we have the slide on the current inflation surge, please?

Again, as always, there are various reasons for the current inflationary surge. There are those who focus on the demand side. Larry Summers and Olivier Blanchard in particular, focus on the fiscal policy shock, especially in the United States. Many others focus on the monetary surge that occurred in most countries in the developed world, particularly in the first half of 2020, but we also focus on the supply shock. Note that, as we had thought, labor tightening has now occurred and has become widespread. It's not just in the US. It is widespread in Europe, it's in my own country, it's very common throughout the developed economy.

That has partly been due to the Great Resignation, and the fact that, for reasons partly due to the pandemic itself, immigration into countries like yourselves and the UK dropped off really quite sharply during this period. What's more, the COVID supply shocks are not over, as you will appreciate from what is happening in China with the lockdown in Shanghai and elsewhere. Now, of course, we have Ukraine as well.

All that has driven up inflation really a very long way, even further than we forecast in 2020, and it has left central banks a very, very long way behind. To put it another way, real interest rates have been declining quite sharply. For example, in my own country, the Bank of England has now raised interest rates by the magnificent amount of about 85 basis points over the last few months. During those months, the increase in inflation has increased by much more, by about 2.5 percent, and it's going very likely to increase by another 2 to 2.5 percent to over 10 percent by the autumn.

That means that, if they go on increasing interest rates by 25 basis points a go, real interest rates will go on declining so that real interest rates are virtually at an all-time low. The prospective continuing rise in inflation over the next few months is likely to mean that even though central banks have turned towards increases in nominal interest rates, real interest rates are quite likely, over the next few months, to go on down.

Now, how to respond to this surge in inflation? One thing that we must all note is that when the inflationary shock is big enough, if they can, people will react to what has happened already to the cutbacks in their real incomes, and they will try to regain some of the lost ground as well as taking account of what is likely to happen. It is not just future expectations of inflation that matter. It is also reactions to what has happened that will be important in determining the future of wages and future inflation.

Central bank confidence in anchored expectations, in my view at any rate, is overly optimistic. The wage price spiral is already underway, in my view in your country and mine, though perhaps, not quite yet in the Euro area. Now, could we have the next slide on, "Should nominal interest rates rise faster or slower?"

There are many arguments for raising interest rates faster. The central banks have become way behind the curve. I listened to a very interesting conference at the Hoover Institute last Friday where many of the speakers said that frequently. As I've already noted, real rates are exceptionally low and are still falling, despite the tendency for nominal rates to rise. Central banks are beginning to lose their credibility and, if not now, may we require even more restrictions and recessions in the future as stagflation takes hold?

Of course, there are always counter arguments for a slower increase in nominal interest rates. Many markets, financial markets and housing markets, have moved, after decades of very low interest rates, into extreme territory. Many have been unprepared for sharp rises in interest rates, partly because they've never seen them during their working lifetime. A soft landing may still be possible, though I think it's becoming increasingly unlikely.

In particular, Ukraine is going to cause a major decline in real incomes. I would emphasize here that that's going to be far worse in Europe and the United Kingdom, which import grain and energy, than it will be in your country, which exports these. Germany, in particular, is concerned with what might happen if gas gets cut off. I even saw an account that suggested that if that should occur, its real incomes would fall by something like 12 percent in a year. There's no great wish for policy to add to pressure in a condition in which your energy might get cut off very largely, and in some respects entirely. Of course, uncertainty is very high. Can we move on to the next slide about the medium-term future?

Partly as a result of the particularities of the Ukraine war, the European Central Bank and the Bank of England are currently accepting arguments for "slow and steady." The ECB hasn't even started; it's still got negative nominal interest rates at a time when inflation is rising at 7.5 percent. That is extraordinary. The Fed, at least, has turned more hawkish in recent months, and a number of emerging market economies have already been forced to respond much more urgently to the inflationary pressures.

It's going to be an extraordinarily difficult exercise to return inflation to target without having to raise unemployment, perhaps significantly. Concerns about the stability of employment, and of financial markets, may restrain the speed with which interest rates are being raised. That makes it quite likely that the result, at least for a time being, two or three years, may well be stagflation.

If there is stagflation, there are a number of consequences. It's not going to be good for central bank credibility, and therefore for central bank independence. Potentially it could lead to fragmentation in the EU area as the weaker countries find that their interest rates rise faster than the stronger countries, though that is offset by the fact that the energy crisis may have its strongest effect on Germany and Austria.

The effects on politics more broadly are going to be very disturbing. It is very difficult for any incumbent government to remain popular and in power when inflation is rising as high as it is at the moment, and unemployment is beginning to rise as the central banks put on the brakes.

Finally, from me, what are the longer-term implications over the next few decades? In our view, they're going to be quite largely dominated by demography, which is largely predictable, and geopolitics, which I'm afraid is not. That demography is going to be adverse, whereas in previous decades it has been incredibly beneficial, huge tailwinds. The working age population is going to be falling, whereas the dependent population, particularly the old, is going to be rising. Taxes fall mainly on incomes, and production and consumption of those of working age population, while the old have to receive care and Medicare expensively from the central government.

The fiscal outlook is not good, and there are those like John Cochrane at Stanford who argue that as long as the fiscal outlook remains difficult, it's going to be particularly hard to restrain inflation on any permanent, stable basis. Geopolitics are adverse, at least for the time being.

Finally, other factors to consider: the reversal of globalization, as I said, it would be adverse. Climate change is going to be very expensive. There are some hopes maybe we can employ the available workforce in Africa more effectively. Technology can help us out. We're going to need every little bit of labor-saving technology that can be produced to release workers to look after the old people like myself.

Maybe medical advances will help. One of the reasons why the old are so expensive is they become incapacitated with the diseases of the old, like dementia, Parkinson's, Huntington's, and arthritis, of which unfortunately medicine has so far not made much in the way of inroads. Talking of that, I'm now in the happy position of going to hand over for the rest of this presentation to my colleague and coauthor, Manoj Pradhan, who has the advantage of being with you in person, whereas I'm afraid that I've got to be transatlantic. Manoj, over to you.

Manoj Pradhan: Thank you very much, Charles. And thanks, Raphael, and to our host, for having us here. It's a very difficult act, going after Charles, so I'm not going to try. What we thought we would do for my segment is talk a little bit about the pushback that we've received to the thesis, and since it's a financial markets conference talk a little bit more about how markets have seen what has transpired in the last few years.

The first kind of ethereal pushback around this was always around timing, as Charles said. It's not certain that things will pan out necessarily very quickly for such slow-moving factors like demography, but in financial markets one of the phrases that we use very often is, "it's not the speed that kills you, it's the sudden stop." Those disinflationary forces of demography over the last 35 years, if they have slowed down, that is likely to have an impact much faster than most of us realize.

The formal pushback, first of all, has always been, "Why didn't it happen in Japan?" In fact, we didn't start writing the book until we had written this chapter. If you don't have an answer for this, there isn't one. It's a long chapter, so I refer you to that. The simple answer is the time Japan had its slowdown was a time when the rest of the world had labor coming out of its ears. The Japanese corporate sector really, while it's looked upon as something that was encumbered by rising debt, understood this, and they used outbound FDI [foreign direct investment] very aggressively to invest heavily in China, not only in manufacturing, but in services.

Rather than being a very closed economy, where you have a narrow framing problem of demography and inflation trying to explain each other, it was a very open, dynamic corporate sector that took advantage of this global surge of labor [and] saw the opportunities outside were much better than in Japan, which explains much more subdued growth within, but a massive surge in outbound FDI over the last 30 or 40 years.

The second bit has been elderly and savings. There are many papers that have come about. I think probably the one I like the most was the one presented at Jackson Hole, where there was a link made to inequality and interest rates. It was fantastic, because it's one of the few times you see a loose concept in our minds, like inequality, being brought down to brass tacks and numbers, which shows you how much the interest rates could have declined.

We look at it slightly differently. Number one, we think that a lot of these aging and savings related papers miss out on one massive change in the composition of spending for the elderly, which is dementia. Both Charles and I have had personal experiences with dementia in our families, and we can tell you categorically that the amount of care, personal and monetary, that it takes to look after an elderly person with a neurodegenerative disease is something that we have not seen at a macro level in the past. For that particular paper, rather than looking at inequality as an exogenous given story, our approach looks at inequality as endogenous to the changes that China and demography brought upon the world.

When you look at it from that perspective, I think the changes that we are about to see in bond yields become more clear. The private savings that went into the bond market are hardly likely to pursue bonds. If there is even a modest selloff, and yields continue to rise, they're not going to chase negative returns.

Technology, Charles has already spoken about in the environment. That makes my job easier, so I'm going to push on to the next bit, which is to talk a little bit about something that was mentioned at yesterday's dinner as having spawned more papers than you can count on all the fingers of all your hands, if you multiplied them 10 times over.

Our simple take on this is that the Phillips curve story still is alive and well. I think there was a 2014 NPR interview in which [James] Bullard said, "If you look at it in the context of a murder mystery, the Fed murdered the Phillips curve." We think it's a crime that they don't have to confess to it. They're still alive and well.

What in fact did happen is that China put it in a coma. If you look at the left chart, these are moving coefficients that you'll see in any Phillips curve model, which show you that the relationship between growth or unemployment and inflation became much less empirically meaningful and got to a level where, by 2019, in the Fed's review, it didn't look like a really useful forecasting model anymore.

However, most models, I won't say all of them, most models don't dig one level deeper to find out why inflation turned out the way it did. In our opinion, if the disinflationary surge from demography in China, which we represent on the right side of the chart, were the dominant factors, then you've got a large, positive supply shock that led inflation lower, where China set the equilibrium wage for the global economy, but you've got very, very, very decent growth. If China's inflationary surge is mostly over, which we think it is, then that overlay on top of a Phillips curve, which is still alive, is now being taken off. That should allow the Phillips curve to assert itself.

China itself, we think, has gone through a significant transformation. It's still going through that transformation. The two ways of looking at the China effect on global inflation is to look at their own path in the future. There was a lot of talk for a while on the consumption-led model that China's economy is going to follow. That looks more like a mathematical rebalancing than economics. In Japan, the labor market really never was able to absorb the shock that Japan went through, and because of that, investment had to do more of the changes.

In China, it's a very similar story. For very political reasons, you cannot allow masses of unemployed, which means the changes have to happen at the corporate level. State-owned enterprises still dominate the landscape, which gives political control. The private sector does about 60 to 70 percent of the employment, which is why the PBOC [People's Bank of China] has found it very difficult to find a channel of transmission in the pandemic, and technology gives you the productivity.

This is the three-pronged model that China is looking for, but it doesn't look like it's an outwardly beneficial model. They're trying to minimize the political shocks at home. If you look on the right-hand side, this is one of my favorite papers, again from the Federal Reserve, which talked about the surprisingly swift decline in manufacturing employment. The beauty of the paper was they went product by product and looked at, once the Permanent Normal Trade Relations Act of 2000 was passed, how certain products that were covered by tariffs went across to China and came back to the United States as imports. That did not change manufacturing value added but led to a huge drop in manufacturing employment that was then absorbed into construction and other sectors.

If you're getting reshoring, reshoring will have a very different effect from what people expect. Yes, there'll be increase in Capex. It will be an increase in the output per worker of the United States. But is it going to be disinflationary? That's not clear, because someone like Apple, if they are onshoring manufacturing production, from their point of view producing in the United States might well be a second best. It's not economic reasons that have pushed them back to the United States. If it's geopolitics or any other supply chain concerns, then that is an added cost that they will have to pass on to consumers. Some of the benefits of reshoring might be less useful than we believe.

With that, I'll move you onto my third part that I wanted to talk about. There's been a lot of discussion about where neutral was. Raphael had a great question on opening night about where the neutral interest rate is, and I did a bit of a straw poll asking people. Really, it's as divided as Charles's slide suggests, so I wanted to focus a little bit on how markets look at it.

Broadly speaking, it's helped me, being far more simplistic than Charles' incredible mind, to think of the global central bank group as a cycling peloton. The guys who move forward very quickly are usually reined in by FX [Foreign Exchange] appreciation. If you're lagging too far behind, you're punished by FX depreciation and rising interest rates.

That's indeed the way it's turned out. We've got very clear leaders and laggards, and it gives you a sense of how markets have tried to play the inflation theme. The laggards have been relatively clear. Japan has been under recent attack. Sweden and Australia have been pushed into tightening much faster, years faster, than they really thought they would. On the other hand, as Charles mentioned, emerging markets have been given absolutely no leeway, given their past historical failings, and that has actually put them in a pretty decent position.

Brazil has hiked tremendously. Mexico has hiked by a large amount. New Zealand and Korea have managed to inflict demand on their housing markets, which are significant, which puts them in pole position, and they are the ones where markets are now looking to receive interest rates, to look for FX depreciation. It gives you a sense of how they have dealt with the search for neutral.

This is an incredibly complex and difficult condition for markets to determine. The broad and simple way we looked at it, from a markets point of view, is through forward rates. If you take the 1-year, 1-year forward as some estimate of the terminal rate, and the 5-year, 5-year nominal as some estimate of the equilibrium, or neutral, rate and the longer-term future, it gives you some insight. Of course, they're not perfect measures, we all know that, but it gives you some insight about how markets have treated that.

The way I think they have thought about it is that the actual nominal interest rate that is required to regain control of inflation will depend on their particular level of inflation. Expectations, current level of demand, all of these need to show some evidence of being suppressed before markets are convinced that we have hit or exceeded neutral. Without a peak in inflation, without some positive real rates, and without some damage to the economy, markets remain unconvinced. Who can blame them?

The concept of a nominal neutral has been really hard, and you can see it in a few ways. The first is, you can see it in the bond market. Bond markets have been in a very unusual position. I would say it's not quite worthy yet, but we could think of it as another conundrum. It's one of the first times that nominal interest rates have been below breakeven inflation at all tenors, whether it's a 2-year, the 5-year, or the 10-year. Of course, just as we put the slide up, it's reversed in the last two weeks. It's a commentator's curse.

Broadly speaking, I think what that does is it makes it really difficult to understand what the role of inflation index, or TIPS yields, is. If you look at or zoom in on our recovery, for the most part, because nominal rates remain anchored at some level, whenever breakevens have moved one way, real yields have simply mirrored that. There are two exceptions, and we're living through one of them, which is particularly timely. The first time was after the Georgia elections, in which it became apparent that a huge fiscal package would be passed sooner rather than later. The market said whatever monetary policy stance is in place has to change.

That was the time at which real yields and breakeven inflation both moved in the same direction. That took the nominal interest rate up to a higher plateau and kept it there. Today, we're going through a very similar change, where markets have interpreted the 1-year, 1-year, and the 5-year, 5-year changes very differently. I'll talk about that in a second, but this is fascinating.

The way markets have looked at leaders and laggards is very, very clear. If you look at Brazil, Brazil's 1-year, 1-year, and 5-year, 5-year rates have flatlined, around here. This is the period over which the Fed has become increasingly hawkish. The amount of hikes that have been priced in have gone from 75 basis points to 50 basis points, and fluctuated. For an emerging market to do this is unthinkable, given the paradigm in question. But because we responded to a common shock, because we responded earlier in Brazil, you have seen that they've been able to hold their own.

On the other hand, if you look at the United States, the 1-year, 1-year curves really started moving up only around September of last year. In Sweden, that has happened only in February, with the result that the bear flattening of the 1-year, 1-year, 5-year, 5-year forward curve, or the yield curve, has happened at very different times. You can see the lag relative to the fundamental inflation spikes. In Brazil, it starts in October of 2020, very, very early, and moves on to a level where markets are fairly confident that they've got control of the domestic economy.

In the case of the Fed, it has moved significantly, and probably to a very, very nice and negative level. In Sweden, it has happened in February of '22, where they have been forced into hiking. The market's search for neutral is really a difficult one, and whenever they are uncertain, even though there are arguments for moving faster, in the case of the Fed, and moving in 50-basis-point clips, if you look at the action over the last few days, the 1-year, 1-year has flattened out. Which means the market is taking the Federal Reserve's comments from last week to mean that, "Well, look, we're going to move at the pace that we suggested. Take 75 basis points if necessary, or maybe not at all."

The 5-year, 5-year has continued to move up, and that tells you that the market thinks that there is still a repricing of how much tightening is needed in the economy. If the pace is a little bit more measured than they might have been prepared for, the bond market will act like a vigilante. You see some of these stories playing out: the attack on the BOJ [Bank of Japan] through the currency. Since these slides...so much changes within a week, it's impossible to change everything....inflation has gone up 2.5 percent. Breakevens are rising up much faster. Those kinds of stories really compress any central banks that might think about lagging and push them into the core of where monetary policy needs to be.

All that remains is for me to talk about what the outlook of all of this tends to be. From my point of view, we might just see a role reversal. In past cycles, what we have seen is two things: the Federal Reserve and markets start by looking at US monetary policy on a very inward basis. Over a period of time, when foreign FX comes in and foreign weakness comes in, that's when they start thinking a little bit more and markets start pricing in dollar strength and start thinking about what the international effect on US monetary policy will be.

This time around, that story might be a bit different. It seems that if you look at three domestic drivers, if you look at where the output gaps are going to go, where housing is, and where labor supply is, all of these look like they'll be a positive force for keeping inflation at a higher level in the advanced economies, whereas they're not really a problem at this point in time in emerging markets. We might just have a situation in which real rates that are very low in the advanced economies might need to stay high. It's not clear to us that advanced economies' central banks will be able to even cut interest rates in a mild recession. It might not be disinflationary enough.

Emerging markets, on the other hand, some of them might be able to ease policy rates even as the Fed is hiking, which is something we have not seen very often. I'll leave it there. Back to you, Raphael.

Bostic: Thank you for that, both of you. Thank you both, for that very interesting conversation and presentation. There are a number of questions, as you might expect, that have come through. I'll just get into them, and I'll add some of my own as we get closer, as we start that conversation.

The first one, that has the most votes, is around this notion that Charles talked about in terms of yields and the idea that real rates are still falling. The question is, "Given that the 10-year TIPS has risen about 125 basis points toward December, it seems misleading to say that real rates are still falling." Charles, the question is: does that make you feel better, the recent movements in TIPS. How should we think about that?

Goodhart: Maybe better, just not enough. The real rates are simply what is happening to CPI [Consumer Price Index], PCE [Personal Consumption Expenditures]. They've been going up, and nominal interest rates have not been rising as fast as the price indices have been rising. As a result, real rates have been going down. I think the markets have been way behind. They've been way behind, if I may say so, partly because they have taken a great deal of notice, quite naturally, about what the Fed has been saying. The Fed has been saying, "Don't worry, inflation will be coming back quite soon. It's all transitory."

Unfortunately, inflation hasn't been coming back. With the continuation of the Ukraine war, the continuation of what is happening in China, and the longer the inflation spike continues, the more that workers will try and get recompense for the reduction in their real incomes. I think that both markets and central banks in the developed world...it's not just the Fed, and you're actually better because you've moved more than the Bank of England and the ECB [European Central Bank], though they're more at risk from Ukraine, obviously. I think that markets have been lulled by optimistic commentaries from the central banks, which have not turned out so far to be realistic.

Pradhan: I'd only add one small thing. I think Charles is absolutely right, and the timing, as you mentioned, really bears that out. It's after the Fed dropped "transitory" that a lot of the real yields started rising, because the view was, "If it isn't transitory, we're going to have to hike a lot, and perhaps we could give a helping hand." It could also be that the market looks at this and says probably this is not going to be enough to get inflation under control and we'll push TIPS yields higher in order to aid with the process, of course, a give and get. I think it's worked very well.

Bostic: A lot of the conversation that you've had has been about the rate side, but we do know that there is balance sheet policy that's happening as well. There's a question here that suggests that there's been a lot of easing and tightening, and financial conditions driven by QE and QT. How does that get incorporated into your thinking about these things?

Goodhart: That's a very difficult one, because we've never been here before. There are many differing views. There are views that suggest that QT will only have an effect of half a percent equivalent on interest rates or less. My view is rather different. I think that it could have a much bigger effect. I think another reason why longer-term Treasury yields have remained so low is because a combination of the Fed's purchases, central bank purchases generally, QE up till now, combined with those intermediaries which more or less have to buy Treasuries for their portfolios has meant that everyone who wanted to get out because they saw the inflation coming had already effectively done so.

When the Fed not only leaves the market, but reverses and starts tightening, and indeed, some other countries worry about the security of their holdings of Treasuries in a geopolitical problem, it could be that there could be difficulties in our countries, the UK as well as the US, and indeed in Europe, in finding buyers for the vastly increased supply of Treasuries at anything like present levels.

Pradhan: I'd make two short points. One is of endogeneity. If you look at estimates from the Federal Reserve Bank of New York, the risk premium on 10-year yields has been rising quite significantly. If a lot of the QT policies, or raising of interest rates, had happened perhaps last year when nominal GDP was rising everywhere, the rate of corporate revenue growth and income growth was very strong, people were able to absorb those interest rate hikes a lot easier, perhaps the risk premium would have been a little bit more subdued.

I think the timing at which QT is going through, when many people are worried that you are constraining balance sheets into a slowdown or into a recession, is the part that magnifies that risk premium. On a longer-term basis, my personal opinion is I find it very difficult to reconcile the CBO's debt profile, which shows a really huge increase in debt to GDP over the next 20 or 30 years, to what seems to me, and maybe I'm mistaken, a thought process that says the balance sheet of the Federal Reserve is going to go back and stay at pre-pandemic lows.

It's difficult for me to think that the biggest issuer of safe assets in the world is going to issue them at a hugely increased rate, and the biggest and most credible buyer of those assets is going to walk away and be able to stay away. The ability of the market to absorb that gap might just not allow balance sheets to remain very low in the long term.

Bostic: Let me just stay on this, and then we have a series of questions about demographics that I definitely want to make sure we cover, but the question here is really about some of the FOMC members seem to think they're not very much behind the curve, and that there were good reasons for making the turn a little later. The question is, do you agree? I think I know what your answer to that question is going to be, but I'm also curious as to what you think the central bank should be doing about it, or whether they're so far behind that there's nothing to do? Or, that all is lost.

Goodhart: I find a rather upsetting asymmetry in the way that central banks react to inflationary and deflationary crises. When the onset of the great financial crisis occurred, and when we got into the COVID crisis in the first and second quarters of 2020, central banks were prepared to cut their interest rates by 1 percent, 2 percent, or whatever. But there seems to have been almost a convention that you don't raise interest rates by anything like such a large jump, especially if it's unexpected, perhaps out of fear of spooking the market completely.

I think that the management of large-scale interest rate changes, in response to major crises, has become asymmetric. I think that that is a pity. Back in the 1970s, when I worked at the Bank of England, we thought nothing of raising interest rates by 100 basis points, or 200 basis points at times, at a go. I think that the long period of success in achieving low and stable inflation would have put central banks in a position where they became totally unprepared and unwilling to consider large-jump, upward changes.

That's not true in emerging markets. I think that there actually was a case when people realized, in central banks, in the late autumn of 2021, that they'd got it wrong for having a 1 percent change. I think if they'd done that, we'd be in a much better position now. However, now things are a bit late. If you take the standard mathematics of the standard Taylor reaction function, the central banks more or less everywhere are something like 5 percent behind the curve, and you can't deal with that in the go.

I understand the argument for doing 50 at every meeting and then seeing how things work out when you have got, say, four meetings of 50 under your belt. All I can say is don't assume that four meetings of 50 will greatly change, necessarily, the inflationary situation. You may have to reconsider where you go from there, by the end of this year.

Pradhan: Just looking at some of the market numbers this morning, 5-year breakevens were around 3.2, and 10-year breakevens are lower than that. I think the confusion on the part of the markets partly comes from looking at the part of the forecast where the disinflation over 2022 and 2023 is very benign, and the path for unemployment and growth is equally benign. It makes it very difficult to understand whether the Fed is willing to go and push into a deeper recession in order to get control of inflation, or are we going to be beholden to positive changes on the supply side to make that forecast come true?

Besides that, I think the opportunity that lies in front of the advanced economy central banks is they know what the problem is. When emerging markets started, every three months they would have to reassess how much further they would have to go because inflation was rising. At least you've got a goal, I think, that you're getting at.

Bostic: Thank you. I said we were going to turn to demographics. The first question is, "How concerned should we be about an abortion ban, in, say the US, for women's labor force participation rates?"

Goodhart: Not my field, I would say. I think the answer is not a huge amount. Remember, the abortion ban will only occur in a number of states, and it is not going to be too difficult or too expensive for those who wish to go through that to travel to a state where it will still be perfectly possible to have an abortion. At least, that's my understanding. Living over in the UK, I'm not in a good position to answer that question. It's not a question for a foreigner.

Pradhan: I have nothing to add on that bit, but I will quote something that I saw in one of the IMF seminars that was held, in releasing one of the reports, is that the participation rates in one of the key sectors for women where women make up more than 70 percent of the labor force, which is education and healthcare, that has not yet reached pre-pandemic levels. That's been important, because in past expansions women were very heavily protected, and their ability to raise employment in that sector was an important part of the recovery process. If we've lost some of that, then there may be more social issues to deal with than we've had in the past.

Bostic: That's true. Charles, I would say that the incidence of this thing, in terms of people being able to move, is important and is not equal across the whole population. I think that's one of the things that a number of people have concerns about there, but we'll actually have to watch and see how this all plays out. It will be interesting.

The next question is, "Don't you think the reshoring trend is misstated? The assertion here is that US manufacturing won't bring labor-intensive operations onshore to the US, but they will reshore to more stable partners, and companies will continue to seek efficiency. They won't abandon efficiency altogether." What's your thinking on that? How do you think the repositioning or relocation of manufacturing is likely to play out?

Goodhart: It's a difficult question. I think that many manufacturers will want to try and maintain resilience by having their plants in a variety of countries, but they will also want, I think, to focus in many cases on their home country. As Manoj correctly said, one of the better features of our forecasts is that we think that the extent of reshoring will lead to a recovery in fixed investment in our countries, an increase in productivity per worker in our countries, much more than in the past.

Overall GDP growth will go down with the slowdown, and even the decline in the working age population and the number of workers, but production per worker will, I think, recover really, potentially quite sharply.

Pradhan: I would say that the question, the way it's framed, it almost seems like the person who's asking the question is asking from the perspective of an economic transition of reshoring. If that's the case, then I think there is more merit to the question where the parts of production that are selectively onshore, it might be the ones that are more profitable. If it's a geopolitical shock, or it's a shock to minimize disruptions to the supply chain, these are not economic considerations. You may have to reshore parts of the production process that you like or don't like, and that's where the problem comes in.

Bostic: All right. I'm going to ask one more question. We're just about out of time. We've got 90 seconds, and so I may have to cut you off, but the question here is, "Considering that retired people are fit at least 10 years after 65 in Europe, Asia, North America, what's the age limit that you guys used in the study? Should we see that as sort of a release valve for some of the demographic trends that you call out?"

Goodhart: Perhaps, but trying to raise the retirement age is one of the most politically difficult measures. Putin has massive overall control over the Russian people, but when he tried to raise the official retirement age in Russia, there was so much opposition he actually largely had to drop it. The same is true for Macron in France.

Changing the official retirement age is very, very difficult. That means that if that is politically constrained, the question is, will more of the old retired choose to go on working? The answer would be, yes, to some extent, much more so if you can cure the degenerative diseases of the old. That's the real crux. That's where we ought to put enormous amounts of pressure: curing and dealing with Parkinson's and dementia ought to come very close to the top of the priority list.

Pradhan: I'll add only two lines. Charles unfortunately makes it very difficult for this book to be read, because he's incredibly active at his age. I would just say, everyone is not Charles.

Bostic: We will end with that. Charles, Manoj, thank you so much for a great presentation, and great discussion.