Maurice Obstfeld: Inflation, COVID-19, and the Economy

In May of this year, the Labor Department’s Consumer Price Index, a top gauge of inflation, showed that April 2021 prices had jumped 4.2% over those recorded in April 2020. Prior to this, inflation had remained relatively dormant. But COVID-19 changed that.

In this episode, Maurice Obstfeld, Professor of Economics at Berkeley, and a nonresident senior fellow at the Peterson Institute for International Economics, discusses the current state of inflation, where we might be heading, and the impact of COVID-19. He also talks about unemployment, possible corporate tax hikes, and provides his advice for the Biden administration as it navigates these choppy waters. 

ABOUT MAURICE OBSTFELD: Maurice Obstfeld is the Class of 1958 Professor of Economics at Berkeley and a nonresident senior fellow at the Peterson Institute for International Economics.  His research focuses on the global economy. He was also a visiting professor at Harvard between 1989 and 1991. He received his Ph.D. from MIT in 1979, following degrees from the University of Pennsylvania and the University of Cambridge. In 2014-2015 he was a Member of President Obama’s Council of Economic Advisers, and from 2015-2018 he served as chief economist at the International Monetary Fund. 


Podcast Transcript

Eric Jaffe: As a result of the COVID-19 pandemic, the prices of some goods have been skyrocketing, opening the door to a passionate debate about the degree to which we’re experiencing inflation. Inflation has proven to be an extremely thorny topic. Some economists have been skeptical that rising prices are a cause for concern, others disagree and see the sharp rise as a dire issue that needs to be urgently addressed. While the recent rate of inflation has been hotly contested its significance is indisputable to policymakers. Inflation can erode consumers’ purchasing power but it can also lower the cost of borrowing.

My guest today has decades of experience to help us make sense of the current state of the economy and offer insight into the role inflation is playing. Maurice Obstfeld is the class of 1958 professor of economics at the University of California at Berkeley, and a non-resident senior fellow at the Peterson Institute for International Economics. He’s also served as a member of President Obama’s Council Of Economic Advisers, and as chief economist at the International Monetary Fund.

 Listen in as Professor Obstfeld and I explore the finer points of the inflation debate, the impact of the Delta variant on our economic recovery, his advice for the Biden administration as it navigates these choppy waters, and where we may be headed next. Professor Obstfeld, welcome to Deciding Factors. So great to have you on.

Maurice Obstfeld: Thanks Eric, I’m glad to be here.

Eric Jaffe: So I thought we could start by talking about inflation. It is a subject of much debate out there right now. Perhaps we could start by having you help us understand the terms of that inflation debate. Does the data currently point toward a sustained or temporary inflation and what would change your mind in either direction?

Maurice Obstfeld:  Well, what the data point to Eric, is two main factors that determine inflation. One is the state of demand in the economy. When demand is very high and particularly when output and employment are above what we can think of as normal, full employment levels there will be more inflation. The other critical component is inflation expectations. When workers expect more inflation they expect higher wages to be paid. When firms expect more inflation in the future and expect costs to be rising they will jack up their prices and so expectations are critical.

The key issue for central bank policy is how do you manage that policy to keep inflation expectations anchored, that is at your more or less long run inflation target? At the moment, what we’ve seen over the last few months is quite high inflation rates in the US compared to recent experience. So the debate that is going on is over whether that is a temporary phenomenon associated with the reopening and with disruptions to supply chains due to the pandemic. Or is that going to feed into expectations in a way that creates a major problem for the Fed?

We’re experiencing some unusually high rates of increase in the consumer price index and actually even more so in the producer price index, which is worrisome because those producer prices will feed into the pricing decisions of firms. But if these price changes start to level out, then we could return rather quickly to lower inflation rates closer to the Federal Reserve target, which is about 2%. The Fed is betting right now for the moment that this is temporary, that this is not going to feed into market expectations, but with every passing month of high inflation, the risk of unanchored expectations grows and the Fed becomes more nervous.

Eric Jaffe: I’ve heard you talk about median prices as a more useful metric perhaps than consumer price index or even producer price index. Is that still the case and could you just explain why perhaps that’s a better metric to use?

Maurice Obstfeld: Sure. It’s customary for central banks and analysts to try to filter out volatile components, which tend to have large temporary movements from inflation data. The basic idea of all of them is to filter out outlying observations. Whether those are very big increases or very big decreases, the items that have a very big increase one month may not have a big increase the next month.

A couple of months ago there was a huge increase in rental cars, rental trucks for reasons connected with the pandemic. People weren’t traveling that much. Rental car fleets were paired back, and then suddenly you have reopening and a huge demand for these vehicles. So big spike, and then in the July data these numbers fell. So it’s useful to filter these things out.

Eric Jaffe: I wanted to get your take on the impact of the American Rescue Plan on the economy and on inflation. There is a debate ongoing. Larry Summers, former president of Harvard, former treasury secretary, former chairman of the Council of Economic Advisors and famous economist, he’s arguing effectively that we’re risking what he calls an “inflationary collision.” Because of the size of the $1.9 trillion relief bill, basically that if it does kick up inflation, the size of that bill, that the Fed could inadvertently cause a recession because they would eventually try to squelch that inflation with higher interest rates.

Maurice Obstfeld: The summer scenario is one where the Fed gets behind the curve, as it were, and suddenly realizes that inflation expectations are in danger of becoming unanchored. To deal with that they might need to increase interest rates faster and harder than they would otherwise. The Fed doesn’t want to get into that territory, and I would expect them to react aggressively if they get information. That is a real danger. They obviously don’t think that at this point. Summers thinks it’s a bigger probability then than they do, but that would be a very bad outcome because it would be recessionary for the US economy and for the world economy.

If you look at inflation data for the US, inflation at the consumer level has indeed increased much more than it has in other parts of the world, in Europe and China and I think it is likely that the American Rescue Plan had something to do with that. You can’t give everyone $1,400 and expect that there’s not going to be an effect on spending. And for an economy that’s trying to reopen and where the supply response is not nearly as fluid as it would be normally, that’s going to get you some price increases.

So that is what we’re seeing now and what the Fed is saying is, “Okay, that was then. People got that money when they got it. They spent it. To the extent they’re saving it that’s not inflationary.” What does inflation going to look like going forward now that the American Rescue Plan has had a large part of its impact? That’s what the Fed is saying to itself.

Now, that being said, there are two other fiscal initiatives. There’s the bipartisan infrastructure bill with about a half a trillion more in additional spending. The reconciliation bill touted at a headline number of 3.5 trillion. You could ask what about those? And for those I would argue that given the time horizon over which they are going to be rolled out, which is something on the order of a decade, the inflationary impact and in fact the budgetary impact is likely to be pretty small. Those I don’t think are factors we should worry about too much in thinking about future inflation.

If you look at the inflation experience of the US compared to say Europe, it looks very different. I think part of that is the very aggressive US fiscal response. I mean, not just the checks but other elements of the American Rescue Plan. And of course there are other issues such as the very large increase in shipping costs between the US and China, which is larger than that between China and Europe and that’s fed into inflation also.

Eric Jaffe: How will the Fed make their decision in reality about whether or not to hike interest rates in 2023 versus 2024?

Maurice Obstfeld: I wouldn’t rule out that if inflation surprises them by not receding, let’s say early in 2022, that we don’t see rate hikes in 2022. I mean, there’s no commitment not to do that. If I were a fed governor, I would be looking very closely at market indicators of expectations, although those are frequently erroneous survey measures of expectations. I’d be looking at the progress of the Delta variant and how that might affect activity.

Eric Jaffe: You’ve mentioned Delta. What impact has this latest Delta wave had on the trajectory of the global economy and in our recovery?

Maurice Obstfeld: Delta is a major problem for the world economy. It is wreaking havoc in parts of East Asia, which had thought that they had this all under control. For example, you look at South Korea, they had done quite well but it’s hard to keep a virus out, it doesn’t respect borders. And now they have a fairly low vaccination rate of the population compared to the US and certainly compared to Europe and they’re really suffering.

China is having outbreaks of the Delta virus as well. So nobody is immune and it’s going to be a big challenge. I think that if you look at Europe, they’ve actually pulled ahead of the US in vaccinations, partially because some of the governments have just ramped up the penalties for not being vaccinated in terms of what services you can access. They’re actually having above expectations growth indicators, both the last quarters GDP growth, and the behavior of purchasing manager indexes indicate very strong growth in the US. If anything, we were downgrading our growth expectations a little bit.

For the developing world where many parts of it, vaccination coverage is very limited. Even in the rich countries, which are less vulnerable because they have more vaccine coverage, we should be very worried about what happens in these developing countries. Because these countries, if they do not extend vaccine coverage to significant fractions of the population, and if you look at Africa we’re talking about 2% coverage, these countries are going to become laboratories for new variants, which could be even more transmissible and more lethal than the Delta variant and we will not be able to keep those out of our countries.

I mean, the experience of Delta originating in India, which seemed to be doing fairly well up until the emergence of Delta, is a real cautionary tale for us. So there’s been talk within the G7 and the G20 accelerating vaccine deliveries to developing countries. I mean, globally, under 5 billion people have received vaccines. We need more like 11 billion people, and that’s not even talking about booster shots, which could be very useful for Delta. So we’re way behind the curve and we need more concerted international action.

Eric Jaffe: President Biden recently called for a global minimum tax on corporate profits. I’m just curious for your take on that. Is that a good idea?

Maurice Obstfeld: I think it is a good idea. I just don’t think that electorates are going to have much patience with the idea that corporations can escape their fair share through accounting maneuvers that shift profits between jurisdictions. Whether this would actually be a game changer in terms of revenues is another question. And to some degree, the devil is in the details of how this has worked out and how you bring into the fold, jurisdictions that are reluctant to go this way. You look at a place like Uzbekistan, which has a very low corporate tax rate and relies on it for attracting inward investment. How do we bring these countries on board in a way that also recognizes that they have legitimate development needs?

Eric Jaffe: Unemployment is low at somewhere around 6% but there are nearly 8 million fewer jobs than pre-pandemic. Why do you think employers are having a difficult time actually filling jobs right now, and are there any policy changes that you’d recommend looking at to help bridge the gap?

Maurice Obstfeld: I think part of the problem is simply the fact that labor markets have become quite disrupted as a result of the whole pandemic experience. People are thinking about changing jobs, thinking about career choices. The fact that there is this excess demand paradoxically may make people more picky about accepting jobs, particularly if they want to move into a new area because there isn’t a sense of I better take this job or else nothing else will come along. I think this is going to get resolved. It’s been slowly getting resolved.

It may also be that participation rates rise over time. They rose slightly in the last jobs report, and that could become a trend. One of the very important positives of the many positives in the last US jobs report is that the number of people working part-time for economic reasons that is on involuntary part-time work declined quite a bit.

I mean, remember that there have been quite a number of businesses that went under. So these matches between employers and jobs have not been preserved as they were to a greater extent in Europe. We actually do see a fairly high level of quits in the economy right now, so I think this will be resolved. One thing that we’re pretty confident was not the culprit was extended unemployment benefits. Because to the extent that we can look across states at this point, we don’t see stronger employment growth in states that withdrew extended unemployment benefits.

Eric Jaffe: Well maybe finally we could end with some forward-looking advice for the Biden administration, as they navigate these complex and daunting challenges from employment to getting legislation passed and beyond.

Maurice Obstfeld:  I think the policies they’re pursuing cut in the right direction and will be of immense benefit longer term, both through physical infrastructure and broadband as in the bi-partisan bill. And the elements that have been talked about for the reconciliation bill, which will help families, help women stay or come into the labor force, put children on a better basis to learn and accumulate human capital long-term. Those are all transformational initiatives, which I think over the long-term will have very big payoffs.

I think the focus on climate again is what a few years ago you would have characterized as a long-term investment. Now looks increasingly shorter term as we contend with temperature anomalies and weather anomalies. It seems on a weekly basis in some part of the world you have some unprecedented flood and we’ve seen these now in Germany and China and in Tennessee. These are not only causes of human misery, but they’re real shocks to the economy. I advise is to go full steam ahead on these initiatives.

Eric Jaffe: Well, Professor Obstfeld, really appreciate you coming on the show and fascinating conversation. Thank you so much.

Maurice Obstfeld: My pleasure.

Eric Jaffe: That was Maurice Obstfeld, professor of economics at the University of California Berkeley and a non-resident senior fellow at the Peterson Institute for International Economics. What I found most striking about our conversation was the degree to which fears of inflation can be a self-fulfilling prophecy. In other words, even sophisticated economic phenomena are susceptible to the old saying that perception is reality. This has proven to be the case, even in the few weeks, since Professor Obstfeld and I recorded this interview, as prices rose even more quickly in July, further fanning the flames of the inflation debate.

We hope you’ll join us next time for a brand new episode of Deciding Factors featuring another one of GLG’s council members. Every day GLG facilitates calls with experts across nearly every industry and geography, helping our clients with insight that leads to true clarity. Feel free to leave us a review on Apple Podcast, we’d love to hear from you. Or email us at if you have feedback or ideas for future show topics. For Deciding Factors and GLG, I’m Eric Jaffe. Thanks for listening and stay safe out there.


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