World Economic Update

The World Economic Update highlights the quarter’s most important and emerging trends. Discussions cover changes in the global marketplace with special emphasis on current economic events and their implications for U.S. policy.

This series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies and is dedicated to the life and work of the distinguished economist Martin Feldstein.

MALLABY: Thank you. Welcome to today’s Council on Foreign Relations World Economic Update. This series is dedicated to the life and work of the distinguished economist Marty Feldstein, a friend to many of us here at the Council. We have over five hundred members registered for today’s meeting, but we’ll try to get to as many questions as possible in the second half of the meeting.

So we’re gathering at a time when I think the core dilemma for the world economy is fairly easily stated: Rising inflation argues for the withdrawal of fiscal and monetary stimulus; but on the other hand the spread of the Delta variant argues for the opposite, for continued stimulus. Different countries are processing this dilemma in different ways, but I think it’s fair to say that across the world central banks in particular are running a pretty fraught experiment. If they can exit this unprecedented stimulus which they’ve delivered since the start of the pandemic without creating serious inflation, an exchange-rate shock, a market crash, et cetera, their credibility as economic policy superheroes will be strengthened. But of course, if they get tripped up by any of these hazards their credibility is going to suffer and we’ll all pay the price. Central banks are amongst the most highly functional of the public institutions that we have. None of us should want to lose that asset.

So with us to discuss this precarious moment we have Rebecca Patterson, director of investment research at Bridgewater; Adam Posen, president of the Peterson Institute; and Isabelle Mateos y Lagos, a managing director at BlackRock.

Adam, let’s start with the Fed, which is telling us that it will remove monetary stimulus very slowly. It’s been making the argument that it’s best to tolerate some inflation and run the economy hot to get discouraged workers back into the labor force, but clearly I think we could all agree that there is some level of inflation at which the Fed’s stance would be wrong. And right now, we have had one reading of core inflation that was in the highest in thirty years. This high inflation has more than made up for the inflation undershoots that we had before, going back to 2015. And I think maybe less talked about but pretty crucial is that just as I look at the newspapers, it feels like the inflation—the fact of inflation has become a news story, and so it’s seeping into the public consciousness and therefore it is fair to ask whether inflation expectations will remain anchored.

So I guess, Adam, the question is, at what point might the Fed be wrong with its determined patience?

POSEN: Thank you, Sebastian. And I’ll be interested in what my colleagues Isabelle and Rebecca also have to say on the topic.

The Fed is, I think, already likely to be wrong on their forecast. They have been very insistent that inflation is going to fall all the way back down to 2.1, 2.2 percent on core PCE, meaning basically at target, next year. I think they’re overly confident about that. But I don’t think that we need to worry about them being too patient. In fact, I think if anything I need to worry about them being impatient.

The camps about discussing these things, as you put it very well, Sebastian, seem to be divided into those who say inflation is transitory therefore we don’t need to worry about it, and inflation’s going to last more than a year and therefore we need to freak out about it. And I think the response is more realistically inflation’s going to last more than a year before coming down but that’s OK.

And so all the arguments that Chair Powell and others have made about catching up the economy for past inflation undershoots, catching up the economy for people put out of work I think are buttressed by the idea that we’re actually going through a structural transformation. I mean, I think this is what Delta tells us, that it’s not going to go back to just the way it was before. And while people paid a lot of lip service to that, particularly about industries like restaurants and in-person retail and tourism, I don’t think—and about households just sort of reverting back to spending out of their savings—I don’t think that’s right. I think Delta persuades people that this is going to be a recurring, ongoing problem, this meaning not just COVID but the issue of pandemics and long-term issues. And if we’re going to be having a supply shock that takes a while to work out, then it’s quite reasonable to have inflation above target for a little while. That helps grease the wheels of adjusting.

The other point is that we were so long sure that we couldn’t get inflation up that this was a source of uncertainty, a source of problems with monetary policy expectations. And so the idea that there’s a two-sided risk to inflation rather than just all being on the downside I think is probably a positive thing.

All that said, I expect that the Fed, therefore, is unfortunately going to pull the plug too soon. There will be people screaming that they’re already too late. I think realistically they’ll be tightening up by raising rates by the end of next year, and they’ll have to tighten more than a tiny bit. I wish they’d hold off longer, but that’s where I think we’ll be.

MALLABY: Rebecca, I’m wondering two things here.

First is sort of do you—do you agree with Adam? Do you agree with his point that a structural transformation in the economy—from remote work to the sort of reconfiguration of superstar cities and who wants to live there, who wants to live out, and so forth, all that stuff he’s saying—justifies a continued period of higher inflation as the economy adapts? So, first, I’d love to hear your thoughts on that.

But also, can you bring in the debate about fiscal? Because, clearly, we’ve moved from enormous stimulus—and that’s now coming off with the expiration of the, you know, special unemployment insurance provisions and so forth, and we’ve got the uncertainty around how much Biden gets his tax-and-spend plans through Congress. So perhaps you could bring in this fiscal angle as well.

PATTERSON: Sure. Sure. Well, and it’s great to be here with you all today.

So I guess the first point is I would agree with Adam. I think that the risks to inflation are probably more on the upside than the downside looking at the year ahead or so, and I would also agree that there are some structural changes underway that are going to be part of that. Supply chains I would argue there is a cyclical element, but there is also a structural element as a lot of industries realize they want to be resilient as well as low cost. And that resiliency has a cost, which means it’s going to turn into inflation as you don’t always have the lowest-cost provider, place, workers, et cetera.

But there’s a couple additional elements on inflation I’d bring in. One would be wages. We’re seeing an incredibly tight labor market, notwithstanding the latest nonfarm payroll report, and I think that is going to keep upward pressure on wages. And then the other one that’s just now starting to get reflected in CPI is rents, which are lagging home prices but are starting to rise and we believe will probably continue to rise probably quite rapidly as we look at the next year ahead, probably longer.

And so, yes, of course there are some elements of inflation which are tied to COVID that should be transitory, but we think the dominant force is probably going to keep inflation higher than what currently is baked into markets, which is fascinating. If you look at market pricing today, it’s treating COVID more like a natural disaster where we get this dip in growth, spike in inflation, and then everything quickly reverts. And we think that market pricing—either inflation’s going to be higher than we think or the Fed is going to have to tighten a lot more than is priced in. It’s going to be some combination of the two, and the Fed will decide which way it tilts on that outcome. But either way, something is priced incorrectly. So we think you’re looking at more tightening, more inflation, and then how much of both we’ll see in the—in the next year or so.

The interesting part with fiscal, I think, Sebastian, is that, you know, historically when we’ve seen this much fiscal spending we’ve had a dire economic backdrop. And certainly at the beginning of COVID that was the fear, that we could have a prolonged recession coming out of it. But the stimulus—you know, trillions and trillions of dollars initially, and now we’re looking at another possibly two to three trillion (dollars) in spending before the end of this year potentially—is coming at a time when household balance sheets are actually stronger than they were pre-COVID. Household wealth is at all-time highs. Savings rates are coming down but still very much higher than they were pre-COVID. So you have fiscal spending coming on to of an already-strong economy, and obviously that’s creating demand that’s outstripping supply, and that is inflationary.

It’s interesting that it’s getting into the body politic, that we’re seeing politicians now debating about inflation as a problem for the first time in decades and President Biden talking about taking steps to push down oil prices because they don’t want inflation to be something that affects voters’ intentions as we go into midterms next year. But I think we’re in a—in a new paradigm, really, where fiscal will continue to play a more important role than it has in the past, at least until central banks have more normalized policy, which is going to take a while.

You know, if you’re at the lower bound and you’ve done a lot of QE already, there’s only so much you can do to stimulate growth so fiscal has to play a bigger role. And we’re seeing that in the United States, certainly, over the last year, and I think we’ll continue to see that, and we’re seeing it as well in Europe. And I think Japan is more of a question mark. We’re seeing it in the U.K. So I think we’re in this paradigm where fiscal’s the dominant lever driving economic outcomes and it’s being facilitated by the central banks, which are trying to keep borrowing costs low.

MALLABY: So, Isabelle, let’s hear more from you on the Europe question that Rebecca raises there. I mean, Europe’s in pretty strong shape, certainly relative to some moments in the past that we can all remember. I mean, vaccine rates are high. Household balance sheets are strong. The European Central Bank has raised its growth forecast repeatedly. You know, not surprisingly, therefore, inflation is picking up a bit but actually less than in the U.S. And in the face of all this, the European Central Bank is promising to keep going with quantitative easing. For those of you who enjoy Margaret Thatcher echoes, Christine Lagarde said, “The lady isn’t tapering.” So do you think the ECB is taking too much risk in continuing with QE, or how do you—how do you see this?

MATEOS Y LAGOS: No, so I think it’s useful to contrast the situation with respect to inflation and growth in Europe and in the U.S. In the U.S., I would agree with everything that Adam said with perhaps the addition of a(n) element that, you know, while inflation is likely to stay elevated and well above the Fed’s forecast for quite some time, we think it is going to fall from the current really eye-popping level and settle maybe around 3 (percent).

In Europe, inflation is expected to peak barely above target and then—and then, you know, over the—you know, by 2023 to painfully reach, you know, 1.5 percent. And you know, there’s a range of forecasts, but none of them is well above 1.7 percent. So the ECB is going to continue to undershoot its target, and unlike the Fed in its strategy review it hasn’t committed to a—to a makeup strategy. And so the fact that there is going to be a modest overshoot this year doesn’t mean it needs to do less, and quite the opposite. Based on its own new strategic framework adopted in July, it needs to continue with forceful and persistent monetary policy response because it is at the—at the zero lower bound or effective lower bound, which is below zero in the ECB case, and because it’s continued—forecasting a continued undershoot of its—of its inflation target over the medium term.

So I think, in fact, if the ECB did anything less than the amount of stimulus it has committed to, it would really put in question the credibility of its—of its target. And in fact, there are even today people asking: Why aren’t you doing more, since you are forecasting that you are going to continue to miss your target?

So, having said that, the fundamental backdrop is quite strong, as you were saying. Europe has reached now vaccination rates in terms of share of the population that are, you know, above 70 percent in most cases, above 80 percent in a few large countries. The reopening phase is in full bloom. And the forecasts are now that GDP will return to its pre-COVID level by the end of the year, which is—which is, you know, quite a bit sooner than initially anticipated. So it’s understandable that the ECB and the folks on the ECB Governing Council felt the need to recalibrate, not taper, the amount of QE purchases. But equally, the inflation target is still a long way away and it makes sense to keep stimulating, according to the ECB’s own policy framework.

POSEN: Could I just—

MALLABY: Yeah.

POSEN: Could I just add something quick? And I’d be interested if Isabelle or Rebecca agree.

One of the things that I think is striking, Sebastian, in the U.S.-Europe comparison is how much less unemployment jumped up in Europe than in the U.S. in most of the economies. And probably that’s at least partially attributable to they—most of those economies and even the U.K. outside of Europe linked the aid to people staying in jobs, whether it was bridge loans for companies or benefits for individuals, whereas in the U.S. we were more generous than we ever were from government but we linked it to people actually becoming unemployed in order to file for a lot of the benefits.

And so I think it may be that Europe actually ran that aspect better than the U.S. because they didn’t go through this up and down in unemployment the way we didn’t have the frictional unemployment we have now. But I don’t know if Isabelle or Rebecca agree with that.

MATEOS Y LAGOS: I think—

PATTERSON: I’d agree with that. Oh, sorry. I’ll be quick and then I’ll let you jump back in, Isabelle.

I’d agree with that, Adam. And I’d say that the flipside of that policy is that the wage pressure we’re seeing in the U.S. today—because you don’t have the right mix of workers where you need them—they don’t have to the same degree in Europe, so we’re not seeing the same wage inflation or the same rate of wage inflation that we’re seeing in the U.S. And then I think we could have a whole ‘nother discussion about fiscal in Europe and how the fiscal and monetary are working with each other or not working with each other ahead of Germany’s election later this month. But, Adam, no, I would agree with your point on that.

Isabelle, I’m sorry. I cut you off. Go ahead.

MATEOS Y LAGOS: No, no worries. I was going to say, so I have sympathy for that—for that view. I think to some extent perhaps it’s too soon to tell. And I think if you recall the debates that were taking place at the start of the pandemic when policymakers were trying to decide between, you know, the sort of furlough schemes and the U.S. approach, there was an argument that you will get quicker reallocation of labor in the U.S. system. And to the extent that I think we all agree that the post-COVID economy is going to be structurally quite different to the pre-COVID economy, maybe there’s a case to be made for, you know, schemes that facilitate reallocation of the workforce across the economy. But I would equally wholeheartedly agree with the benefits of the approach taken in Europe versus the U.S.

MALLABY: One more question on Europe, for Rebecca, just before we move on. I think you’ve been looking at the market consequences of the upcoming German election.

PATTERSON: Well, it’s a fascinating time in so many ways. You know, Germany goes to the polls on the 26^th. We won’t know who the next chancellor is probably for months, right, because they elect parties not chancellors, and then you have to have the horse trading to form the governing coalition. And that could take, honestly, till the end of the year easily.

But what seems likely, according to the polls, is that the next governing coalition is going to be fiscally more flexible, we could say, and potentially at least directionally more integrationist when it comes to the EU. And I think the challenge is going to be how much more fiscally flexible can they be, whether it’s—we’re talking about the domestic economy or Europe more broadly, given the constraints they have with the black zero, the debt brake, et cetera, which are written into the constitution.

And so, to me, what’s interesting is we think directionally, assuming we get one of those coalitions likely by the polls, a more—more fiscal spending. And Germany needs it, right? The demographics are working against them. Competition with China is heating up for high-value-added manufacturing. They need to spend. They need to invest. How far can they take it? The further they can take it, I think it’s a support—an important support for growth. I think that has spillover effects to the rest of Europe almost regardless of what happens on the integration front. But that could be the other one to watch.

They are reviewing the fiscal rules for the EU right now. That probably will pause a little bit until we have the next German government, and then we’re going to figure out what they’re going to do. Does it make sense to have a 60 percent debt-to-GDP ratio in this world? Probably not. Three percent deficit rule? Can we make it more straightforward? And while they’re not going to change the master treaty, to the degree they can have any carveouts or flexibility around this it’s going to help Europe escape the trap of having an austerity policy just as they’re coming out of recessions. That’s slowly widened the divergences between the core and the periphery, and I think one of the major factors that leads investors to expect earnings growth to continue to lag the U.S. significantly.

This could prove to be an inflection point which starts to narrow that gap between earnings expectations in the U.S. and Europe. Obviously, some important economic consequences as well. So I think it’s an important day to watch, even though we won’t know the results for a little bit.

MALLABY: I want to move on to the emerging economies, or at least a couple of them, and I have a question here for Adam. In a way it seems that, you know, emerging markets are where the Delta dilemma cuts the tough—in the toughest way. So through 2020 and the first quarter of 2021, I was surprised by how much policy space it turned out did exist in the big emerging economies. You know, they were able to cut rates, deliver fiscal stimulus, and seemed to get away with it.

Today, although there’s a strong case for continuing stimulus because Delta is ranging and vaccination rates are very low, it’s not clear that—I mean, some emerging markets are deciding that they’re got to start hiking. So Brazil I think has hiked four times since March. Others, like India, are holding off and they’re planning to hike maybe next year. But this dilemma between, you know, do you continue to stimulate because you’ve got Delta, you’ve got a low vaccination rate, and growth is suffering as a result, and on the other hand your credibility is lower than it would be in a developed market? That’s a painful dilemma. And I’m wondering how you see the quality of the management of this.

POSEN: I would start, Sebastian, exactly where you did. To me, the striking observation about emerging markets, meaning the higher income developing countries, is exactly what you said. That they had much more room to respond to this crisis than they have had in previous cycles when either disasters hit, or there’s financial trouble in the West, or in Asia. I mean, you look at Brazil. Yes, they’re hiking, but they managed to keep monetary policy relatively loose. With contributions from my colleague Monica de Bolle at Peterson they put out a universal basic income briefly for—to help people who were hurt by this. And so I think for the most part we’ve been pleasantly surprised. You go back a year and a half ago, the IMF was preparing to have to bail out in new programs the World Bank for, you know, an enormous number of countries.

The miseries of people in South Asia, and sub-Saharan Africa, and parts of Central America, where the health systems are overwhelmed and where, thanks to the miserly nature of the U.S. and Europe, there aren’t very many vaccines available is, of course, a terrible thing. But for EM, you mentioned India, you mentioned Brazil, South Africa—I mean, these are economies that are more resilient than we used to give them credit for. And capital markets seem to be more patient with them than we used to give them credit for, although this was already even clear a few years ago.

And so I would just emphasize that the gap between emerging markets and the U.S., in many ways, is closing, from both ends. The U.S. is getting less and less trustworthy on policy and the emerging markets are being seen as having more worth. That doesn’t mean everything’s great. I mean, India is turning inwards, and nationalist, and very arbitrary. And so private investors may take a very different view than the macro side. South Africa, sadly and unfortunately, is being overwhelmed to some degree by longstanding social and health issues that make them particularly vulnerable to Delta. But I have to admit, Brazil is, among others—Turkey for another one, for example, Mexico—are surprisingly on the upside. I think they’ve been far more resilient. And that’s good news. There’s just no getting around it. Let’s have some good news and recognize it.

MALLABY: (Laughs.) Isabelle, let’s go to China which, in a way, I think is maybe the hardest major economy to discuss right now because there’s so much going on. The authorities are obviously fighting with this outbreak of Delta. Growth numbers are slowing down. I saw that Goldman Sachs recently downgraded the forecast for the third quarter from 5.8 to 2.3 percent. A pretty sharp downgrade.

And on top of the obvious macro dilemma that this poses, you’ve also got the fact that the government is fighting to rein in private sector leverage, modernize the way the credit markets work. But that is in tension with the desire to avoid, you know, big financial bankruptcies. Evergrande, the property giant, is the one I the news right now. And people are talking about if they went down they owe so much money to people in the supply chain in the real estate sector in China, and there are so many Chinese families with their savings in condominiums, that this could be a systemic shock.

So you probably can’t comment on the credit of a particular company. I understand that. But nonetheless I wonder if you could talk about how you see China navigating both the sort of macro question created by fast growth in the first half of this year and the sharp slowdown now, and the objective of monetary or sort of financial modernization and avoiding a kind of Lehman Brothers type moment.

MATEOS Y LAGOS: Absolutely. Well, first of all, let’s just say—to link this to the previous discussion on EMs—this question of what happens to China is also obviously crucial for the EM outlook. We do think, for EM, the worst is behind us and that, you know, both fundamentals and spreads can only get better from here in most cases. But obviously the elephant in the room is what’s going to happen to growth in China. We’re absolutely not in the camp that predicts that China’s growth is going to fall off a cliff. I mean, the number crunching exercise is not the most important when it comes to growth in China. But just for the sake of the number crunching, with delayed growth it’s actually tracking around 5 percent in Q3. So a slowdown, for sure, but nothing catastrophic and certainly nothing that we haven’t seen before in 2018, 2019, pre-COVID. You know, there were quarters at that level of growth quite frequently. So no need to panic.

And the main reason for this no need to panic sort of core view is two words in the op-ed published in the China Daily a few days ago, which were: common prosperity. And the two are equally important and really, I think, capture the balancing act that the Chinese authorities have been attempting to strike. And, you know, this year, to be honest, already before the pandemic—before the pandemic there was, on the one side, the worry to keep growing fast enough to achieve the goals of the Communist Party of doubling GDP. On the other hand, avoiding financial instability. Well, now we’ve got an additional element which is everybody needs to benefit from this prosperity. So the parts of the economy, the parts of the market that are taking an outsized share, let’s say, of that prosperity, they get hit on the head by a bit of a regulatory or a strong regulatory crackdown.

But if that goes too far then prosperity that’s safe, then you need to lift the foot off the pedal. Same thing with regard to the functioning of capital markets. And I’ve said for a long time now China may be the only country in the world where it’s good news when the default rate goes up, right, because it means you’re acknowledging credit risks more openly. And we know that’s been the direction of travel. And so, again, this is what the Chinese authorities are pursuing. But we have very strong confidence they’re going to pursue it as much as can be before triggering, you know, spillovers that have a systemic impact. You know, today or yesterday—by our time today, so yesterday in China—today they could have decided to ease monetary policy. They didn’t. Why? Because they think the situation is stabilizing in a reasonably good place.

So, you know, we do think the crackdown in some sectors that are, you know, growing at the expense of the quality of growth, the sustainability of growth, this crackdown will continue. But every time growth slows down, that will pause. And I think we’re going to see this dance between the two goals carrying on for quite some time. But no risk of China growth falling off a cliff, in our view.

MALLABY: I want to open up to members in just a minute, but I’m going to squeeze one last question in for Rebecca about—also about China. Which is that, you know, the other thing that’s happening which complicates the story, of course, is that the government is clamping down in the tech sector. And I guess there’s two stories here. One is, you know, that this is sort of what the freer Western countries would kind of like to do to their tech sector, if they could. So limiting how many hours of videogames teenagers play per week to three hours may be attractive to some people in the West. But then there’s also a sort of more sinister interpretation, which is, you know, this is fundamentally changing the degrees of freedom in which the Chinese tech sector operates, and therefore it could—it could have a dampening effect on innovation in China.

If the second is true, it seems like shooting themselves in the foot. I mean, why would—given how much the digital sector has contributed to the rise of Chinese power in the last ten years, why would the government risk that?

PATTERSON: It’s a great question. And I think my answer is going to echo a lot of what Isabelle just said, in that I think when you’re trying to understand the day-to-day regulatory announcements or policy announcements from China, it’s really important to go back to their policy intent. And one of the great things about China is they’re very clear, not just about their short-term plans but also their long-term plans. And I believe, at least directionally, they try very much to execute what they say they’re going to do. And so in addition to common prosperity that was already mentioned, I would add to that dual circulation. And then, as Isabelle said, there’s a third policy intent, which is continuing to develop the capital markets.

And so regulating the tech companies, I think you can tie it to their policy intent, which is making sure they’re creating space for the small and medium-sized enterprises, the SMEs, to thrive and grow, to avoid monopolistic behavior, to make sure that companies that are moving into the financial arena are in the same regulatory ecosystem as traditional financial companies. It’s funny, because none of these things—if we said them in the context of the U.S.—would blink. Well, yeah, that’s what our politicians are talking about too, whether it’s with DeFi and fintech or some of our big tech companies.

I think where sometimes people observing China from outside get confused is in the announcement, the timing, the execution of these things. But I do think they’re all consistent with the policy goals. And then to Isabelle’s point, yes, some of these huge tech companies are getting hit, for sure. And we’re seeing that in their share prices, and we’re seeing that in sentiment. But to the degree it becomes a systemic risk that threatens growth, to the degree it threatens development of their capital markets and attracting foreign capital, I think the government will course correct, because they want to make sure they’re trying to balance all of those goals at once. But I do think what they’re doing today is consistent with the goals. And so it’s just trying to understand where they’re coming from, where they’re trying to go, and see if these align.

 MALLABY: OK. So I’d like to open this up now to members to join the conversation with questions. And just a reminder that this is on the record. And the operator will now remind you how to join the question queue.

OPERATOR: (Gives queuing instructions.)

We’ll take our first question from Tara Hariharan.

Q: Thank you so much. My name is Tara Hariharan. I work for a hedge fund in New York called NWI.

To follow on from the great discussion on China that Rebecca and Isabelle had, I just wondered if the panelists could share their views on where they think the latest U.S.-China tensions and the fact that even with the Biden administration, even now we have not seen too many shifts away from the Trump hawkishness on China, how you see this affecting global growth, emerging markets, especially given that the trade tensions may worsen in coming months and years. And we also have the attendant complications of the Chinese tech sector crackdown, causing a possible drift even between the U.S. and China in terms of cross-border flows. We’ve heard that the SEC is trying to block additional Chinese IPOs in the U.S. because of these concerns regarding the Chinese crackdowns. Thank you.

MALLABY: Maybe we’ll throw this to Adam, since he didn’t have a chance to comment on China earlier.

POSEN: Thank you, Sebastian. So as opposed to my relative optimism on inflation and on emerging markets, on this front, medium-term, I’m actually quite pessimistic. I think, as I may have said in previous meetings with this group, the level of distrust and animosity between the U.S. and China is quite high. The prioritization of geoeconomic—or, excuse me—geostrategic goals over economic goals is quite high. Rebecca made mention of the dual circulation, I think it’s called, that the Chinese government is engaging—or, the Chinese party is engaging in, which is a form of deglobalization. And of course, the U.S. industrial policies that the Biden administration is pushing are also a form of deglobalization.

Now, it may all be worth it for reasons of human rights or reasons of national security. But from an economic perspective, I think this is very disruptive. And it’s likely to have long-lasting effects. If this persists, it’s no longer about just trade deals and protectionism on tariffs and things, which my colleague Chad Bown has tracked so well and shown how little difference it made, and what many others have done. It’s about technology flows, it’s about human flows, as well as capital flows. The questioner mentioned the issue of stock listings.

You know, old people like me who have been around long enough that, you know, every few years we see a book about the world is breaking up into economic blocs. And for the 30 years I’ve been in this business, that’s never really been a persuasive argument. I fear that now it is, that if this kind of divergence is maintained for the next few years, which it shows no sign of stopping, you start having very different business networks. You start having very different production networks. You start having different standards. And as a result, you get a much more lasting division of the world economy. And I think that’s very bad for productivity, relating to some of the reasons that Isabelle and Rebecca have already spoken about, that it’s just fundamentally anti-innovation.

And even if we put more money into American innovation, and China puts more money into Chinese innovation, if you don’t have free flow of ideas, of people, of capital, of concepts, it’s bad for everyone. So, again, from a foreign policy point of view—colleagues of Sebastian’s at CFR may have different views on this—you know, we can make the arguments about what’s needed. But from an economic point of view, I am actually very bearish on the medium term, meaning three to seven year, effects of the U.S.-China divide.

MALLABY: This feels like a huge issue so I’m just going to extend it and sort of maybe add to it and see if Isabelle or Rebecca wants to comment. It strikes me that, you know, one of the effects of this segregation between China and the U.S., and this duplication of effort, is an enormous need for capital expenditure, right? People are going to duplicate everything in both economies, you know, whether it’s semiconductor fabs or what. And this comes on top at a time when the climate transition is going to require an enormous amount of capital expenditure. Isabelle, Rebecca, do you have reflections on what that does to global money flows?

PATTERSON: We’ve been looking to see if there are any early signs on supply chains, you know, either delinking away from China. We’re not seeing a lot of evidence of it yet, although I think it’s very early days. It takes a while to figure out new supply chains. But I do agree with Adam’s point that the bias of risk is that countries feel they need to—and to your point, Sebastian—that they have to replicate things at home or, you know, reconfigure their supply chains.

And, you know, it’s interesting when you see groups like the Quad meeting, you know, trying to get groups of likeminded governments. And I think that just exacerbates the risk that we could be going in this direction where people have to pick sides. And there’s a lot of countries that would prefer to staddle the middle and deal with both economies. And how is that going to play out in the coming years? I think that’s going to be a huge question we want to follow.

Again, going back to the German election, you know, they’re trying to keep market share. And they’re increasingly with competition with China on high value-added manufacturing goods. And you’re seeing opinion polls where Germans want to have sanctions on China, even if it hurts the German economy. But they get so much revenue from trading with China. So how do you balance all this out? And I do think it has the potential to be one of the big, big macro questions over the coming years, how this game plays out.

I think politically, given President Xi Jinping’s October 2022 focus, right? Whether he gets his third term or not—maybe not whether, but as it’s—as it’s confirmed, and then of course the midterm elections in the United States, both leaders are thinking about what’s the right policy choice domestically ahead of those important dates. And I don’t think that necessarily augurs well for cooperation in the short term.

MALLABY: Next question, please.

OPERATOR: We’ll take our next question from Mahesh Kotecha.

Q: Thank you very much. Very interesting discussion. Very broad ranging.

I’m struck by the downgrade by Goldman of the growth rates in China and not by Rebecca—or, is it Isabelle? I forget which one. The divergence in economic expectations today, it seems to me, have to factor in some views people take, analysts take, on the pandemic’s impact. And I’d like the panel to address specifically what the pandemic does to our way of looking at the future. It seems to me it’s throwing a monkey wrench into our models. It is throwing a monkey wrench into the time horizon of risks, as Gillian Tett likes to point out, with short—with immediate—with far risks being exaggerated and close risks being minimized. So I’d like you to address the pandemic’s impact on the uncertainty surrounding forecasts, and the difficulty of making them.

MALLABY: Isabelle, you want to go at that one?

MATEOS Y LAGOS: Yeah. Yeah, I can say a couple of words on this. I think in terms of the impact of the pandemic on economic growth, there’s really, OK, maybe three blocs. I was going to say two blocs, but three blocs. You have countries, mostly in the West—in the rich West—that have decided to bank everything pretty much on vaccines. And as a result of that, have been able of late to really lift restrictions to a very minimal level. And I think there’s now a strong prior, not an absolute belief, certainly, but a strong prior that we will not go back to shutdowns like we saw last year anywhere, because such a large share of the population is vaccinated. Versus other countries, mostly in Asia, including China, Australia, and New Zealand which, for whatever reason, went for a strategy of eliminating COVID entirely, and start shutting down their economies as a result when you had an outbreak which was counted on the fingers of—you know, with cases counted on the fingers of both hands, right?

And I think most recently there is a realization in the latter group of countries that this is not sustainable. This might have made sense if the pandemic had come and gone over the space of a year, but now it’s very clear—and I’m not an epidemiologist, but I listen to those who are. And they say this thing is going to be with us a for a long, long time. So we need to learn to live with it. And I think we’re seeing an evolution even in China to this view that, OK, let’s accelerate the vaccination program so that we don’t have this horrible tradeoff between growth and health and safety. And I think they came to it a bit—a bit later. But, you know, the rate of vaccination of the population is increasing there very fast as well. And so that means that in the future we should be pretty confident of the ability to deal with the pandemic with limited economic damage. Not zero damage, but, you know, manageable damage.

MALLABY: OK. Let’s take another question.

OPERATOR: We’ll take the next question from Hani Findakly.

Q: Thank you very much. And thanks for this very good discussion.

Just wondering in terms of your views about the future trends in the global economy and the restructuring that have discussed, will the demographics play any role in those terms. And who are the winners and losers, given, for example, expectation of population decline in China and rise in other countries, like Africa?

MALLABY: Rebecca.

PATTERSON: Sure. I can start. Well, demographics are an increasing challenge across much of the developed world, and a growing number of the emerging economies. China you mentioned. I’d also add Korea. There are others. And so I think governments, policymakers are trying to figure out, what can I do? If I don’t have the labor force to support growth, my options are throwing more capital at it or figuring out a way to increase productivity. And/or I do something to get women to have more babies, or I get a lot more immigrants in my country.

I think what we’re seeing in places like China is they are trying to help families have more children, but that’s something that it’s not clear it’ll be successful, and it could take decades. So in the—and you don’t want to spend a lot more capital, given that they’re trying to deliver the economy not add more debt. So that goes back to raising productivity, which means a focus on technology. And that keeps China in conflict with the U.S. and the West, who are worried about them having technological dominance, not just for what it could mean economically but also geostrategically. I think you’re seeing a similar reaction in lots of countries, where they’re saying: OK, if we don’t have demographics working in our favor anymore we have to find ways to get more productive. And that includes industrial policies. And I think it does include more fiscal spending. And so that’s a reason why central banks are going to do what they can to keep interest rates low, to try to facilitate that.

MALLABY: Isabelle, Adam, do you want to add on this demographic question?

POSEN: Yeah. If I could build a bit on what Rebecca said. I think she’s right to link it to these other issues of productivity and policy going forward. I would emphasize that one of the ways of interpreting the relatively low inflation we’ve had, of course, is to say that we are in secular stagnation, and that even these very large fiscal actions are not enough to pull us out. They have to be sustained to keep growth up. And one of the simplest ways to make sense of that is to say: OK, Japan was correct. Demographics do matter. That risk aversion goes up, savings stays up when you have an aging society. And so as Rebecca says, that puts us in a world where there’s a lot more emphasis on policies trying to make up for that.

And I think it’s, of course, a shame—I’m just going to say something obvious, but CFR people have to keep hearing this—it’s a shame that there isn’t more global migration and better attitudes to immigration, because that doesn’t directly translate into productivity, but it can make a huge difference to the demographics. And immigrants and migrants generally contribute much more than they take out of the system. And they generally increase the fertility rate and reduce the average age. And as Michael Clemens, Center for Global Development, has been arguing very presciently for a long time, I mean, this is million-dollar bills on the sideline.

Relatedly, the issue of women’s labor force participation. Again, it’s—labor supply is not the same thing as improving productivity but improving labor supply often improves productivity by increasing competition and raising the average quality of workers. And it also, again, substitutes for some of the aging out of workers. And Japan has been very successful with a set of policies to raise female labor force participation, starting with Prime Minister Abe. And some of the part of the contentious reconciliation fiscal package in the U.S. that the Biden administration is pushing includes things like that. And I’d rather see that kind of policy than an industrial policy.

But anyway, I just—I just want to emphasize that I agree very strongly with Rebecca and with the questioner that there is some linkage between our sort of stuck economies, if not secular stagnation, and our slow productivity growth with demographics. I used to resist that, but I don’t think I can argue against it anymore. (Laughs.)

MALLABY: Thank you, Hani. Next question, please.

OPERATOR: We’ll take the next question from Donald Daniel.

Q: Thank you.

I want to follow up, actually, on the demographic issue, because ever since about 1985 or so, with the introduction of sonograms—the general introduction of sonograms so that now people can pick the sex of their child, sex ratio have been going, you know, very much in favor of males and very much against females. And we now talk about missing women, you know, that kind of thing. And that looks like it’s a long-term trend that’s not going to be changing soon. And I’m wondering, in light of your demographic discussion, what do you see might be the economic consequences of this, particularly for countries? You know, even Korea is going very much in the wrong direction, I would argue, on this. So thank you.

MALLABY: Anybody want to take that? While you’re thinking about it, I mean, I might point you to this week’s Economist magazine, which has an entire sort of long, three-page, article about the way that when you have the kind of selection that you’re describing, what you have is, you know, too many men. The men fight each other for the chance to marry the women. It creates conflict. In polygamous societies, it’s even worse because the powerful men marry more than one woman. And they link dysfunction and failed states to some of the issues that you’re raising here. But that’s my—that’s my filibuster. If anyone’s got a more substantive answer—

POSEN: No, I think actually you’re more substantive than you give yourself credit for, Sebastian. (Laughter.) And not just because you quote the Economist. I think misogyny and toxic masculinity is a lot more powerful and a lot more destructive than we used to acknowledge. I mean, there were plenty of critics, primarily female and people of color, who raised it, but that the mainstream acknowledged. I touched on this a bit in my Foreign Affairs article in April/May about the idea that we have this nostalgia for manufacturing because it’s big men doing heavy stuff being the breadwinner. And so, you know, people don’t want to make economics about wokedness, but these kinds of actions you can say, well, it’s just biology. But, no, as a number of recent studies have shown, there are matrilineal societies. There are societies where the policies and culture go the other way. It doesn’t have to be this way.

And I think the remarks about the missing girls and women that Amartya Sen and others pointed out, it’s actually a long time ago that this was pointed out. And again, not to keep harping on the same thing, but, you know, female labor force participation, and actual laws to empower women economically, matter. My colleagues Pinelopi Goldberg and Simeon Djankov have done a huge cross-national study on this. They started at the World Bank. It’s now at Peterson. And they look at these laws that have been in place about economic access for women. You know, do you need a male relative to come with you to get not just a driver’s license, but a business loan.

You know, and let’s not forget that Iran, Afghanistan, Turkey had very vibrant female-led business sectors and education and lower rates of fertility and higher ages of marriage, and all those things that I think are good, before the various reactionary revolutions and turns in those societies. So sorry if you think this is not substantive, but I just—I just think we can’t get away from some of these issues, that these are meaningful economically as well as politically and ethically.

MALLABY: Isabelle or Rebecca? Are you happy to leave it there or do you want to chime in? Happy to leave it. OK. Let’s get another question. Oh, sorry.

MATEOS Y LAGOS: I was just going to say that it’s a theme that’s come up in several of the issues. But the sad reality is, much as we’d like to believe the opposite, we seem to be in a phase of history where politics trumps economics. We’ve seen this with Brexit. We’re seeing this to some extent with the U.S.-China competition. We’re seeing this with the lack of willingness in most countries to open the borders to immigration, even though there would be all the economic benefits that Adam and Rebecca mentioned. And this is just another aspect of it. We can think, and we can argue, and we can demonstrate compellingly all the benefits of, you know, allowing women to take full part in the economy, and we should keep doing it. But I think unfortunately the politics right now trumps a lot of the good economic analysis.

MALLABY: OK. Let’s go to another question.

OPERATOR: We’ll take our next question from Mark Finley.

Q: Thanks to all of you for an interesting conversation. This is Mark Finley from Rice University’s Baker Institute.

I’d be—given the EU’s proposed border adjustment, you know, as part of the climate policy, I’d be interested in the panelists’ thoughts on the potential macroeconomic implications of the adoption of that.

MALLABY: Isabelle, you want to have a crack at that?

MATEOS Y LAGOS: Yeah, sure. Well, so, first of all, it’s not—it’s not a done deal. It’s a proposal that the European Commission has put on the table. It’s going to be haggled over for quite some time within Europe. And I think macroeconomic impact would be—would be at two levels. On the one hand, you know, Europe has decided to put a price on carbon emissions as a key ingredient in its toolkit to meet its goal of being a net zero economy by 2050. Carbon is an input into all sorts of things that go into the economy, so that’s a supply shock, one way or—one way or the other. And that’s why it’s a good thing that the plan also provides for a lot of investment and other spending to make up for that. Whether it will match up exactly, the jury is still out.

In terms of the external effect, I think the policy intent of the EU is hopefully we won’t have to impose a carbon tax on anybody because the incentive effect will be so strong that all of our trading partners will themselves adopt a carbon price. That would mean we don’t need to levy that tax. Again, whether that works like that in practice or not, I have my—I have my doubts. But obviously that’s not insignificant to the—to the ultimate impact. So it think it will be very interesting to see how this debate progresses in the coming year, if it has this incentive effect or not. But what is for sure is, with or without CBAM, the carbon prices are going to go up both in Europe and in the rest of the world. And that, for sure, is going to have a macro impact.

MALLABY: OK. Let’s go to another question.

OPERATOR: We’ll take our next question from Wei Argi (ph).

Q: Thank you.

I had a question for—could any of you talk about how the policy uncertainty may pose the risk to the U.S. economic recovery? By the way, my name is Wei Argi (ph) and then I’m from China Business News. I’m a reporter. Because we have the U.S. debt ceiling, and then also there is the House Democratic set the goal to vote for the infrastructure bill by the end of September. Also, the start of the new fiscal year, there is a risk of government shutdown. All the things just jam around the first weeks of October, maybe. So these policy uncertainties may pose risks to the economic recover. Thank you.

MALLABY: Maybe Rebecca can take this, and then I think we’ll have to wrap it up.

PATTERSON: Sure. So it is really interesting, all those different events coming up that you listed. And yet, if you look at financial markets right now implied volatility is incredibly low. When you look at equities, fixed income, currency markets. The one place where you see risk embedded in markets is really in equity options, where people are buying protection. But outside of that, it seems like folks are just kind of looking through this. And certainly, there is a huge political momentum to get this fiscal spending through, to avoid a government shutdown, have successes, especially ahead of the midterm elections in 2022. It doesn’t mean you couldn’t have a failure it doesn’t mean that you couldn’t have a policy mistake that gets us into a short-term problem.

I think if that were to happen, while the Federal Reserve certainly isn’t going to react to every little wiggle of the stock market, if you saw a policy issue undermining confidence that would be reflected in market prices, and then start translating into consumer confidence, it probably at the margin would affect the Fed’s reaction function. And so the additional liquidity, versus what was previously expected, would probably, at least at the margin, help stabilize things. I guess that’s a longwinded way of saying we still have a Fed put. (Laughter.) But I think my base case is that we are going to see success on the political side with these events between now and year end. I wouldn’t say it’s 100 percent probably, but it would be my base case that they’ll figure out a way to get through.

MALLABY: It seems to me that, you know, by invoking the Fed put, Rebecca has ended up by answering the question we started with, namely are the central bankers still the economic policy superheroes? The answer “yes” seems to be the view, both on the optimistic take on the economies—the kind of reasons not to panic over above-target inflation, both in the U.S., and it probably will happen in Europe, the increasing space for EM policy that we’ve observed in the last year and a half, more optimism. The only worry seems to more on the U.S.-China side, which remains troubling.

But thank you to all three participants and to all the CFR members who logged on. Please note, finally, that the video and transcript of today’s discussion will be posted on the CFR website. Thank you, everybody.

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