Saturday Night Live (SNL) held a fireside chat with Former Fed Chairman Paul Volcker and current Fed Chair Jerome Powell. Here's a replay of their conversation.
Fed Powell. It is an honor to be on the same stage with you. I think of you as one of the greatest public servants in the history of the Federal Reserve.
Paul Volcker. Thank you. Those are very kind words. How goes it at the Fed nowadays.
Powell. Well, we have a little inflation problem.
Volcker. How bad is it?
Powell. Consumer prices (CPI) have risen 7.9% in the past year. But at the Fed, we focus on the personal consumption expenditure (PCE) deflator, which has only increased 6.1%.
Volcker. Why does the Fed look at the PCE and not the CPI? The CPI is what people pay for things, and the PCE includes a lot of non-market prices.
Powell. That is true, but increases in the PCE run less than CPI, making it look like inflation is less high and harmful. The Fed is in the game of trying to influence expectations, so we picked the lower number of the two.
Volcker. Selecting a price measure simply because it produces a lower inflation rate is not sound monetary policy. Good policy decisions flow from unbiased and accurate statistical information.
Powell. That is fair. But we are in the business of managing people's expectations so picking an index with a lower number helps.
Volcker. What is this rental equivalence that has replaced house prices in the measures of inflation?
Powell. It is supposed to measure what people can rent their house for if they decide to rent.
Volcker. How is that inflation? The definition of inflation is what people pay for things.
Powell. I know. But rental equivalence makes reported consumer price inflation rise less fast when there is rapid house price inflation, and that makes it appear that the Fed is doing a good job. Remember, it's our job to try to manage people's inflation expectations.
Volcker. But people know inflation when they see it. Nowadays, people have more sources of house prices than they did in the 1970s, so actual inflation or experienced inflation must be much higher. So how much higher would reported inflation be if the CPI were measured similarly to the 1970s?
Powell. Based on press reports, it would be double-digit inflation, equal to the highs of the 1970s.
Volcker. Based on press reports? Doesn't the Fed staff know?
Powell. No. If we don't calculate it, we can overlook it and make it appear that things are always better than they are. Remember, it is our job to try to manage people's inflation expectations.
Volcker. That's a section of monetary policy I never read or learned. So what are the critical drivers or sources of this inflation nowadays?
Powell. Most of the increase in inflation is due to supply shortages and bottlenecks emanating from the pandemic. But in recent months, inflation has broadened.
Volcker. I thought the Fed has consistently argued that inflation is always and everywhere a monetary phenomenon. How fast have monetary aggregates been expanding.?
Powell. We don't look at money nowadays.
Volcker. The Fed is in the business of making money.
Powell. That is true.
Volcker. So how fast?
Powell. Broad money has increased by over 40% in the past two years.
Volcker. How much?
Powell. 40%.
Volcker. Uh-oh! And the Fed is surprised by the surge in inflation?
Powell. We are committed to fighting inflation and plan to front-load official rate increases.
Volcker. Front-load? What do you mean by front-loading?
Powell. Policymakers see the Fed funds rate at 1.9% at the end of 2022 and 2.8% at 2023. So we plan to hit those targets earlier.
Volcker. When I was Fed Chair, front-loading involved lifting official rates before consumer prices surged. It seems to me the Fed is back-loading rate increases, trying to catch up to inflation.
Powell. Remember, it is our job to try to manage people's inflation expectations. So far, people and investors still think we are doing a good job.
Volcker. The pendulum of central banking has fundamentally changed, moving away from things it can control and basing policy success on influencing people's expectations. How did the Fed fall into the trap of assigning so much weight to people's expectations and not actual statistics?
Powell. I hope history will show that we are committed to price stability as much as you were. But, remember, we are judged by a different standard---people's expectations (although no one knows how to measure them)--and not actual inflation.
Volcker. I wish someone could give me one shred of neutral evidence that inflation expectations lead to actual inflation and not that persistent inflation leads to higher expectations.
Powell. When facts change, I will retire my views. Thank you.
Note. Paul Volcker passed away on December 8, 2019. So his responses are my words of what I think he would say today.