Episode Summary
Executive Summary: David Beckworth and Joe Gagnon analyze Powell’s Jackson Hole speech through four lenses: the future path of the neutral rate, the sources of disinflation, the relevance of the Phillips curve, and whether the Fed should revisit its 2% inflation target. Gagnon argues r is likely somewhat higher than pre-pandemic due to looser fiscal policy, but demographics still anchor it down; inflation is easing mainly from supply normalization, while sticky services need slower wage growth; the Phillips curve remains useful if made nonlinear and combined with expectations and supply shocks; and the Fed should keep 2% for now but seriously consider a 3% target in the framework review, alongside make-up policy/NGDP targeting.
Main Topics: The future of the neutral rate (r)* (Priority: 5/5): The discussion centers on where equilibrium real interest rates are headed. Gagnon thinks r may rise modestly because of larger deficits, defense spending, and climate-related investment, but demographics and longevity continue to exert downward pressure. Why inflation has fallen (Priority: 5/5): They parse disinflation into three buckets Powell emphasized: core goods, housing services, and non-housing services. Gagnon sees housing and goods as likely to improve further, while sticky services depend on slower wage growth. Phillips curve relevance and nonlinearity (Priority: 5/5): The conversation revisits whether the Phillips curve still explains inflation. Gagnon argues it does, especially when expectations, supply shocks, and a nonlinear response at low unemployment are incorporated. Demand vs. supply drivers of inflation (Priority: 4/5): They debate how much of the inflation surge came from excessive demand, fiscal stimulus, loose monetary policy, and money growth versus supply disruptions from COVID and Ukraine. Gagnon says both mattered, but supply shocks dominated the disinflation phase. The Fed’s 2% inflation target and framework review (Priority: 5/5): Powell reaffirmed 2%, but Gagnon argues the coming framework review should openly consider whether 3% would better reduce ZLB risk and wage/price rigidity, especially if r stays low. Make-up policy and nominal GDP targeting (Priority: 4/5): Beckworth warns against discarding make-up policy after the inflation surge. Gagnon agrees that some memory-based framework—preferably nominal GDP targeting—should remain on the table because it helped the economy recover faster.
Key Arguments: r is likely a bit higher than pre-pandemic, mainly because fiscal policy is looser and debt is larger, but demographics and aging/longevity still push it down over the medium run. The New York Fed and Richmond Fed r measures diverge because they use different assumptions: one is mostly driven by trend growth, the other by inflation stabilization. Recent disinflation largely reflects supply normalization: goods prices are falling, housing should continue to soften with a lag, and only non-housing services remain sticky. Core goods inflation has room to fall further because tradable-goods competition and falling auto/other prices can revert toward lower-cost production. Wage growth and non-housing services are tightly linked; to get those down, labor market cooling must continue. The Phillips curve did not disappear; it looked flat because expectations were anchored, shocks were unusually large, and the economy experienced a temporary labor-force withdrawal and sectoral shifts. A nonlinear Phillips curve is more realistic than a flat linear one; at very low unemployment, inflation can accelerate more sharply. The inflation episode was driven by both excessive fiscal/monetary stimulus and massive supply shocks; the Fed was too easy for too long and should have tightened earlier. The fiscal theory of the price level is not relevant for the United States in this episode because markets do not yet expect fiscal dominance. A 3% inflation target could reduce the chance of hitting the zero lower bound and mitigate downward nominal wage/price rigidity, even if r rises somewhat. The Fed should not abandon make-up policy or framework innovations just because inflation returned; those ideas may be useful in future downturns. Nominal GDP targeting is attractive because it preserves memory and supports stabilization better than a pure price-level framework.
Data Points: CPI peak: around 9% - Beckworth cites the peak inflation rate reached last year. PCE peak: around 7% - Beckworth notes the Fed’s preferred inflation measure peaked near this level. Current inflation: about 3.3% - Beckworth says both CPI and PCE are now near this rate. Core CPI: around 4.7% - Beckworth cites the remaining gap in core inflation. Core PCE: around 4.2% - Beckworth cites the remaining gap in the Fed’s preferred core measure. Atlanta Fed GDPNow: close to 6% - Beckworth notes third-quarter real GDP tracking far above trend. Interest-rate target: 2% - Powell repeatedly reaffirms the Fed’s current inflation target. Alternative target proposed: 3% - Referenced in Jason Furman’s op-ed and discussed as a possible framework-review option. Zero lower bound threshold in public attention: around 4% - Gagnon argues people begin noticing and reacting strongly to inflation above this range. Household longevity effect: higher retirement saving need - Used to support the view that demographics keep r lower over time. Confidence bands for r estimates: roughly 0.5% to 4.5% - Beckworth mentions the wide uncertainty around Richmond Fed estimates. Historical demand shift: largest post-war shift from services to goods in 2021 - Gagnon says this sectoral shift helped fuel inflation. Second-largest comparable shift: 1950 - Gagnon links a similar sectoral shift to another major inflation spike. JOLTS quits rate: back to pre-pandemic level - Beckworth cites labor-market cooling as evidence wage pressure may ease.
Pivotal Quotes: "we see the current stance of policy is restrictive, putting downward pressure on economic activity, hiring inflation, but we cannot identify with certainty the neutral rate of interest" — Jerome Powell (quoted by Beckworth): Used to launch the discussion of r uncertainty and its future path. "Inflation has moved down from its peak a welcome development, it remains too high." — Jerome Powell (quoted by Beckworth): Powell’s Jackson Hole message framing the disinflation debate. "I think probably our star is going to be a little higher over the next few years, and possibly longer than it was pre pandemic" — Joe Gagnon: His core view on the likely medium-run path of the neutral rate.
Implications: The episode suggests inflation is cooling but not solved, and future policy hinges on whether r stays low or rises. Listeners should expect continued debate over 2% vs. 3%, more focus on labor-market cooling, and renewed interest in framework reforms like make-up policy or nominal GDP targeting.
About Macro Musings
Hosted by David Beckworth of the Mercatus Center, Macro Musings pulls back the curtain on the important macroeconomic issues of the past, present, and future.