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.

MALLABY: OK, I think we can get started. Welcome to today’s Council on Foreign Relations World Economic Update. I’m Sebastian Mallaby. I work here at the Council. I’m the Volcker senior fellow for international economics.

We have a great panel to work about the world economy. Over there is Caroline Atkinson, who is the head of policy at Google. We have Doug Rediker, who is at Brookings and also at International Capital Strategies. And next to me, Jeromin Zettelmeyer from the Peterson Institute for International Economics.

So we’re going to get going here and talk for half an hour or so and then invite members to join in. So we’re going to start with the U.S., not only because we’re in the U.S. but because it feels like the bit where policy and news maybe has some of the most variability on either side. And it’s obviously a fairly good period. In the last two quarters we’ve had 3 percent or 3.1 percent growth, fairly broad-based uptick, consumer spending, business investment, exports all doing well. Clearly the markets are happy. Employment numbers are Friday were good. And there’s a negative spin and a positive spin one hears about this stuff. And Caroline is going to tell us which to believe.

The negative spin is that there was quite a lot of inventory adjustment in the most recent quarter. And if you strip that out, it wouldn’t be 3 percent growth, it would 2.3. But the positive is that, you know, this kind of number is pretty good very late in the recovery. It’s been going since 2009, after all. It comes despite two hurricanes. So really, on balance, pretty good performance. Should we be—how do you think about the upside and the downside? Should we be glass half-full or half-empty?

ATKINSON: Well, I think in the immediate term, we can be, you know, reasonably sanguine. Yes, the economy was doing quite well in recent months. But if you step back and take a longer view, and we can see this in the politics, the economy has clearly been underperforming. It’s underperforming in providing the kinds of jobs that people want. It’s underperforming in providing housing where people want it. And it’s underperforming on measures that are increasingly important, such as inequality.

And when we look ahead and wonder what’s going to happen to health care, what will happen to the tax bill, I think there are risks—especially what’s going to happen to Medicaid—I think there are risks that some of those structural problems will get worse. And just on your point on, yes, it’s late in the recovery, but we should also remember that this recovery has been a very disappointing one. And 3 percent might be fine, but really we should have had a period—on past performance, we would have expected some period of growth of 4 or even 5 percent to have taken place. And that never happened.

I think there were a lot of policy mistakes, you know, across the board, Congress. And in a way, a failure—I don’t know what these guys think—but a bit of a failure of economists and politicians to understand each other. There has been this fear of deficits and stimulus, in Europe most especially, but also in the United States, that took hold in, I don’t know, 2009, 2010, and really crimped action. And we have never—I remember sitting on this stage some months ago, and the people with me were saying—one of them argued we should be running the economy hot. That’s what really helps the low income. It helps the people at the bottom of the pile. They get work. And I think that’s right. And we really do not have to worry about inflation or high interest rates.

MALLABY: Well, maybe I’ll try that on Jeromin. So this is—you know, running the economy hot feels very tempting. One of your colleagues at Peterson, Olivier Blanchard, has written about the Philips curve, and the way that you appear to be able to, you know, have tighter labor markets and the effect on prices is sort of one-third of what it used to be, in terms of upward pressure on prices. So in a world where the Philips curve is flattening, you can get away with running the economy hot, and you don’t seem to pay a price in terms of asset price inflation—in terms of price inflation. But I guess the risk might be the asset price side. So the question is, you know, if we’re moving—you know, in this environment, should you enjoy the party, push on the accelerator, allow the economy to run hotter? Or do you worry that even if the penalty isn’t there in inflation, it’s somewhere else?

ZETTELMEYER: Yeah. So basically, in the short term I agree with that view largely, and with Caroline’s view, with the caveat that we would want obviously the physical side to contribute to it. And so that is, if you like, the positive aspect of the likely tax cut, right? So the combination—the composition of the fiscal boost that we’ll likely get in the U.S. now, after having gone through several sort of rounds of disappointments and then, you know, regaining some expectation that it would happen, is a problem. This is not the way I would do a fiscal boost in the U.S. I would do it through spending more infrastructure and by having a decent social safety net and by having single payer health care, perhaps. But certainly, the macroeconomic effect I think is a good thing in the short run. So I buy the, you know, short run accelerator idea.

Now, the question is to what extent will it deal with some of those longer-term problems? And my view is there it probably won’t hurt, because it will get some wage growth going, which is still very weak. And so in that sense it could, at the margin, help a bit on, for example, median wages, no? But then we have the broader issues, which is productivity growth. And productivity growth is—remains very low in all advanced countries. And we don’t really know why and how long it will stay.

And, you know, for this reason there’s also a sense that interest—real interest rates may—and nominal interest rates may stay low for a long—for a long time. And that, of course, preserves, if you like, half of the dilemma of secular stagnation. Also, one part of the dilemma is the stagnation bit. Part of it is you enter an environment where normal macroeconomic policies, particularly monetary policy, can do much less, because there’s less room to grow—to go in terms of lowering interest rates. That part of could well be a longer-term phenomenon.

MALLABY: I’m going to come to Doug in a second, I just want to make sure I’m hearing both of these people correctly. So we have somebody who worked in the Obama White House in a senior position. We have somebody who worked in the German government in a senior position. You’re both sounding a little bit, to my surprise, sympathetic to the Trump administration view, that, you know, 2 percent trend isn’t good enough, you can run the economy hotter, you could help these social cleavages by pushing on the accelerator. Do you really think that you can sustain—

ZETTELMEYER: So I’m neither sympathetic to the unrealistic ideas of the Trump administration of potential growth in the U.S. in the long run, nor am I sympathetic to the distributional impacts of the tax cut, or generally the—you know, the form that fiscal policy is taking in the U.S. But, you know, the fiscal stimulus that will come as a result of the tax cut has a positive spillover, which is to achieve—

MALLABY: But employment is full, growth in the last two quarters is 50 percent above trend. Why are you so keen on a cyclical stimulus right now?

ZETTELMEYER: Well, I mean, employment is full is a relative thing when you have had, you know, declining labor force participation in the U.S. And we—you know, we’re really hoping to get some of these people back into the labor force. So, for me, I mean, the critical point is not really some notion of full employment—which is vague for that reason—but whether inflation is ticking up or not.

MALLABY: OK. So, Doug, first of all, do you think that the tax reform will happen?

REDIKER: All right, well, so given that that’s a tough question, I just want to pick up the last comment, and then I’ll go to—

MALLABY: (Laughs.) That was the most frank ducking of a question I’ve seen in a while. (Laughter.)

ATKINSON: Don’t like it.

MALLABY: But anyway, go for it.

REDIKER: No, no, no. I’m going to answer it. I just wanted to say, both Caroline and Jeromin, and you implicitly in your question earlier, you know, sort of glossed over the inflation issue, right? So it’s, well, as long as inflation remains low—dot, dot, dot. And as, you know, the chairman of the Fed said, you know, it’s a conundrum. So I’m only raising it that the normal to-ing and fro-ing of balancing out what you can get away with from macroeconomic, monetary, and fiscal policy, is sort of being thrown into a question mark right now because we don’t have the normal pushback of inflation, that you would have expected to have been much higher now.

So the only point I’m making is as long as inflation remains, you know, a conundrum, and you want to give the benefit of the doubt to the, well, I guess it’s going to stay low for a while so we don’t have to worry about it, then even I, no fan of the Trump administration’s policies, would more or less agree that, you know, you can put the pedal down harder than you would have thought because you don’t know why, but inflation is not the normal resistance point that it would be.

On the tax bill’s prospects, I think there’s two ways to look at it. There’s the substantive merits of the bill—and that’s sort of what we just discussed, so I’ll push that aside. The politics of it: The Republicans are pretty aware that they have no choice but to pass tax reform, some form, because it is absolute political suicide for them to have a reprise of the health care debacle. That does not mean it will pass. It does mean that in spite of individual and collective interests on individual provisions they may or may not like, there is a collective sense of we’re all going to die politically if we don’t pass this.

Now, the problem with it is the House is passing one thing. You know, and you’re all from Washington, so you know the biggest hostility in this town is not between Democrats and Republicans, it’s between the House and the Senate. So the argument that the House is going to pass something that the Senate is just going to take up and make a couple of tweaks, and then they’re going to go to some blissful consensus conference and pass everything, is pretty naïve. So I would assume that there’s going to be a rush to get the House bill through. It will—whether it looks a lot like what’s being debated today and this week or not, let’s assume it looks like it if not identical. Then you’re going to get to the Senate. The Senate is probably going to be much tougher slog. And then assuming the Senate gets something done—and I’m not saying that is a given—but assuming the Senate gets something done, then you’re going to have to reconcile that with the House.

And all this is going to play out certainly not before Christmas, as they promised, but into Q1 of next year. And who knows what’s going to be going on to distract politically from, you know, the single-mindedness of tax reform, including debt ceiling. The end of this year you’ve got, you know, all the appropriations bill to keep the government open. Oh, yeah, there’s that immigration thing that Trump threw in just for his own reasons, along with a number of other things. So the fact that they’re doing it through reconciliation, which means they can do it on a partisan party—you know, Republican Party-only basis—doesn’t mean anything else can be done on a Republican Party basis. The Democrats aren’t going to just simple divorce the two.

They’re going to say, fine, you think you’re going to put this through and it’s going to impede our political agenda—our, being the Democrats. Well, guess what, we’re going to hold up this, this, this, and this over here. Meet me in the middle. And that’s something that—you know, for those who think it’s a linear trajectory to pass it, they’re sort of discounting that.

MALLABY: So, in other words, the whole tax and fiscal part of the outlook is pretty uncertain. And then on the monetary side, let’s just go back to that for a minute, because there’s this incredible turnover in personnel. We’ve just had the announcement of a new Fed chairman. There are three vacancies. If Janet Yellen decides to step down as governor as well as chair, that means there’s four vacancies. Now, apparently, the president of the New York Fed is retiring early. So it’s—I can’t remember another time when the leadership of the central bank has been that much in flux.

What does that mean for, do you think, coming back to monetary policy? You might have a Fed chair sitting around with either a bunch of new people or, in fact, a bunch of empty seats. And he’s been appointed on the theory that’s sort of continuity—kind of dovish continuity. Sometimes Fed chairs have to react against the expectation of them just to prove their own power and independence. And so you think of Bill Martin in 1951 doing the opposite of what Truman expected. You think of Greenspan in the early ’90s tightening, and George Bush blamed him for losing the ’92 election. What do you think is—how do you see the politics around the Fed, both the—all those vacancies and Powell with—vis-à-vis his own—the expectation around him?

REDIKER: Me?

MALLABY: Yeah.

REDIKER: So I don’t expect the Bill Martin surprise. I think Jay has been on the board for the last five years. He’s not coming in with a 30- or 40-year monetary policy academic background. What he’s basically learned has been very much by being a member of the Fed board. And I think the expectations for him continuing existing monetary policy are probably going to be met. Whether the other remaining board vacancies get filled is a political question. We don’t know who the president is going to nominate. My expectation is there was already a sense of wariness in the balance between the Fed board and the regional Fed presidents of the FOMC.

Clearly, if you only have three members of the board, you by definition are emphasizing the autonomy and the independence of the other region Fed presidents. Whether that’s good or bad I’m not going to opine on today. But I do think this is an administration that has been relatively slow in making big appointments and getting them through an otherwise overburdened Senate. So I think you’re probably going to have a bunch of vacancies for a relatively long time.

ATKINSON: And then it will depend quite a bit on—I would imagine—on Jay Powell’s ability to marshal the other members of the FOMC. And I assume that he’s going to be fairly good at that. I would think his job would be helped if Janet Yellen stays on, but I don’t know how she will see that option. But I think it’s very interesting that the administration—that the president chose in the end to go for the dovishness. That would suggest to me that he’s going to keep an eye out also for that balance, if he gets to nominate others. And maybe the easy thing will be not to nominate much of anything. But I think that it’s a little bit like on the fiscal side, that there are—there turn out to be rather few deficit hawks in the Republican Party when you’re talking about tax cuts. And I’m with Jeromin that overall the economy can do with running hotter rather than colder going forward, with a fiscal boost to help the monetary side. I don’t agree with the likely shape of the fiscal boost, but with the—from the balance point of view, I think that both calls are the right ones.

MALLABY: So, Caroline, one of the surprises for critics of the Trump administration has been that business confidence has responded rather cheerfully for the advent of the administration. And that soft data story has, I think, remained pretty constant through—you know, through the last nine months. Is there a point where business confidence starts to drop because of politics, uncertainty? I mean, in some sense you’ve got this paradox of a high volatility president with a low volatility market. That’s one—it’s a kind of financial markets way of saying the problem, but also, you know, you are working now for Google. I don’t know whether the tech sector is going to carry on feeling comfortable and confident given the politics and the shift towards stronger criticism of tech companies. So talk a bit about how you think business confidence is going to perform in the next six to 12 months.

ATKINSON: I think business confidence and financial market confidence are not exactly the same thing. But both are affected by expectations of what is going to happen to the economy overall. We’ve just been talking about the signals that the economy’s growing reasonably steadily, that policy is likely to support that rather than undermine it. And so that’s a reasonably good environment for business investment in the United States. The financial markets will—the sort of low-drama financial markets, let’s say, may mirror the low-drama action.

We have a president that has—you know, makes a lot of comments, but a Congress that hasn’t really done much of anything. And I think the risk for the markets and for business investment would be if things start to—if policies start to be taken, or fail to be taken. On the tax side, I think that business confidence would be hurt if there is no fiscal expansion that comes out—whether it’s taxes or infrastructure or something. Although, the balloon has been going down fairly gradually on that. And Doug would have a better sense of quite what the markets are likely to be building in now.

On the side of business investment, that—there is some genuine potential problems, such as where is the workforce going to come from if you have a very tough and unpleasant immigration policy. So far, we’ve seen the courts stopping that from happening. I think that’s one important piece. Another important piece, obviously, is what happens on trade. So far, that shoe hasn’t fallen, but I think that if there were a big move against NAFTA, for example, that that would also be a very bad—you know, damage confidence, both soft business and what we see in the market data.

MALLABY: So let’s switch a bit to Europe. I want to start with Jeromin. The performance in Europe has been, you know, better than it has been for a while. So I expect that if you’re in favor of running hotter in the U.S., you must be doubly much—(laughter)—in favor of running hotter in Europe. Because, after all, you’re much earlier in the economic cycle there. Unemployment is probably twice as high in the eurozone as it is in the U.S. So I’m presuming you’re going to be extremely dovish to me about this, but there’s a question about how you deliver the dovish policy, right? You said to me, I remember, at some point earlier in the eurozone crisis that you thought the eurozone would not lose members, which was a brave and a sort of slightly—in the Washington context—I think out of consensus prediction, circa 2010, and you were right. And you said it for the right reason, was you said central banks are very powerful.

The question is, will the European central bank remain that powerful as a backstop for, you know, decent growth in Europe? You know, you’ve got the zero lower bound question. You’ve got the, you know, two years left on the clock with Draghi’s tenure, and renewed criticisms from Weidmann of Draghi just recently. You’ve got a question of are there going to be enough German securities to buy, if you’re doing quantitative easing, and you need to include a chunk of German securities in that policy? Do you run out at some point? So talk a bit about how you see the European Central Bank, how able is it to be continue to underpin the recovery in Europe?

ZETTELMEYER: OK, so you’re, of course, right that the recovery is more recent in Europe. And perhaps as a counterpart of that, inflationary expectations are more subdued than here, and actual inflation remains more subdued. But there’s also one important difference in the other direction, which is in the last four quarters European growth, euro area growth, has really been quite strong, about 2.5 annualized. So this is now I think the fourth quarter where this is happening. And that’s almost twice potential growth in the euro area. So that’s really quite strong for the euro area. So there isn’t really a sense that you—I mean, I don’t think you can realistically, or should realistically, try to accelerate euro area growth beyond those 2.5 percent very much.

On the other hand, you have this problem of very subdued inflation expectations, and much still lower interest rates than here, and flat yield curve, and so forth. So, you know, again, I’m a big admirer of Draghi. I think he did the right thing, which is, you know, this ingenious combination of saying we’re going to actually buy less, right, hence not running up against the quantitative constraints that you point out, but we’re going to make it open-ended. You know, it will continue for a while. I think that was a very good way of dealing with these—with these dilemmas.

So basically, my view is that, you know, the European recovery is not really at risk, except for politically induced shocks and maybe shocks coming out of the—out of the U.S. So it doesn’t depend on additional monetary stimulus to simply continue. The big risk in Europe is that even, you know, in four or five years, when we would normally expect another downturn, interest rates are still going to be far too low, and hence the ability of monetary policy to deal with a downturn is far too small. And at the same time, the fiscal instrument that we have in the U.S. will be missing, in Europe will continue to be missing, which has to do with the politics of what’s going on in Europe at the same time. So I’m quite bullish on the next few quarters, on the ongoing recovery. But I’m far less confident that Europe is going to sort out some of these more fundamental problems.

MALLABY: And before the German election, there was some hope—(audio break)—Macron has an opportunity for structural reform in France. That could set an example for other European countries that could use it. If you’re Germany and you’ve been urging that kind of policy for a long time, you should be welcoming this with open arms. And I think the hope was that Angela Merkel, if elected more strongly than she was, might have used the mandate to say, well, right, my legacy will be the solidification of Europe, and that means the solidification of France. It can’t be a zone that’s driven entirely by Germany. We need a strong French partner. Given that we’re now talking about this different coalition now, and Merkel’s mandate has been diminished, what are the political odds that Germany can do something really helpful to France?

ZETTELMEYER: So I think something helpful and constructive and meaningful will happen. It may just not be in the area or euro area reform, right? So Macon himself anticipated this in his Sorbonne speech, by sort toning down the euro area parts and toning up the other parts. So I think there is an agreement—

MALLABY: You mean the other parts, being sort of common border controls and non-economic stuff?

ZETTELMEYER: Yes. Defense, terrorism, non-economic stuff, possibly common market stuff. So I think that’s where we’re going to see some progress. And, I mean, it’s important to remember that all parties will now likely be part of the coalition, if it happens. And it’s not entirely clear that they will agree, right? I mean, there’s, like, a one-third or so failure probability in my view. You may think it’s even bigger. I don’t know. It is—all these three parties are strongly pro-European parties. And they also—like Macron, they see the opportunity of the moment.

The problem is the euro area stuff, right? And here, definitely, it’s become much more difficult for two reasons. First, there is this panic inside Mrs. Merkel’s party that, you know, voters are leaving to vote for the AfD, and that this has something to do with euro area policies, which it no doubt has. It’s not just, you know, the refugee situation. And so, you know, that sort of sets the limit to how far you can go to the—further towards France. And then you have this slightly maverick Free Democratic Party, which basically is very much driven by the trauma of the circumstances under which they were sucked into the general Merkel maelstrom, which is very powerful—as I experienced when I was in Berlin. And they didn’t have much control.

And now they have these two signature issues. One is tax reductions. They’re going to get something on that, but probably not as much as they wish. And the other one is this notion that, you know, we’re going to hold the line and be tough on the euro area. And there’s really—there’s a sense that the political survival of this party depends on really making that point. And that’s slightly scary, I think.

MALLABY: But tough on the euro area means what?

ZETTELMEYER: So they basically reject any further steps in direction of what they consider fiscal mutualization. And anything that has to do with fiscal risk sharing, or making the ESM, the European Stabilization Mechanism—Stability Mechanism bigger or more powerful, is sort of put in that pot. They’re completely against any further relief for Greece. And, you know, when Klaus Regling was here, he rather sanguinely said, oh, you know, this stuff about the ESM is all campaign rhetoric, in the meantime they have taken it back. Well, that’s not the case. I mean, they’re continuing to insist on it, and that puts them really to the right of Schäuble. And so this is—you know, we may just see complete stagnation on the euro—on the euro front.

ATKINSON: But, Jeromin, what—sorry. I’m curious to know what they’re likely to do or what their position is, not about euro mutualization, but just allowing other countries to run the deficits that they want to run. Because for France, just having a larger—doing the tax cuts that macron talked about, doing some infrastructure investment there, might—would bust their budget deficits targets, possibly. But they can fund themselves. They don’t need German help with that. So is there a position there? I mean, is that a way out?

ZETTELMEYER: So, there is a possible compromise that the SPD may support along the lines of let’s babysit countries less and let’s set more market discipline, right? So, you know, you can run your own fiscal policy, maybe with more flexibility than in the past, provided we do not completely get rid of rules, and provided we are really tough on the no bail out principle, and that will then induce, you know, debt, borrowing costs to react quicker, and then possibly countries that do bad things are going to be cut off from markets earlier. So you could get a compromise along those lines. And I’ve sort of wrote a blog immediately after the election, suggesting that that should be Merkel’s strategy to get these guys on board.

The problem is that to make this kind of grand bargain acceptable to the French, and even more to the Italians, you need the third element there, which is, you know, more fiscal buffers.

ATKINSON: We’ll take care of you.

ZETTELMEYER: We’ll take care of you. And that’s what they don’t want. So this is possibly, possibly a bargain that France and Germany might strike. You know, if you put in a little bit of symbolism in there too. But Italy is not going to go for that.

MALLABY: So I just want to come to Doug before we go to members, on Europe. I mean, you hear two things going on here. You hear that, you know, growth is possibly double trend. So that’s good news. And Macron clearly is doing things. He’s done by decree some of the labor reforms. At the same time the structural issues, the mutualization issues, are nowhere closer. In fact, after the German election, they are less on the table than they were. So are you kind of optimistic or negative on the stability—sort of five- to 10-year view, I’ll say. Not the sort of immediate.

REDIKER: Five to 10 years? All right.

ZETTELMEYER: He’s always optimistic on the 10-year view, right? (Laughter.)

REDIKER: All right. So I guess I am more optimistic than the consensus in Washington, because the consensus in Washington is always that Europe is about to collapse. (Laughter.) So I mean, there’s just a general sense that since it’s not the way we would do it, therefore it’s got to end badly. And that was the case before, during, and after the euro crisis where, you know, I was, along with Jeromin, advocating the position that, no, the eurozone is likely not to be any smaller than it was at the beginning of the crisis, because Europe is primarily a political construct not an economic one, something which is often lost to observers here in Washington when they look at Europe.

But one of the points that does concern me is not only the otherwise incompatible positions of not only France and Germany and Italy, but everybody else—we haven’t even mentioned Brexit. But I wanted to just mention banks, because I think that the great fragility in Europe really does reside with the banking system. That’s not to say all banks are bad and that there’s huge weaknesses in every country’s banking system. But what happened at the height of the euro crisis was there was a window given to countries to basically use state aid without the sanction of the European Commission for doing so to stabilize the banking system. And some countries did it, most notably the Germans.

 

The two countries that didn’t were most notably Portugal, small, Italy, big. And the Italian banking system has been an ongoing issue. I’m not going to call it a deep problem, I will use issue. You might want to put quotes around the word “issue”. But it’s a real issue. And it’s a political issue. It’s an economic issue. It’s a financial issue. It is both directly related to the banks themselves and to the Italian economy, and to European banking more broadly.

And in part, what is being discussed right now is not only the ESM reform that Macron has championed and that Jeromin mentioned, but there’s also an effort to try and create, through the single supervisory mechanism at the ECB, a new means, a stricter means by which banks in the euro area account for their non-performing exposures, their non-performing loans. And this is, while not explicitly intended to hit Italian banks, it really hits Italian banks. And Italian banks are already fragile in terms of the ability for the state and the populace and the banks themselves to grapple with their balance sheets. And so that’s the one area that I would say is likely to be the source of if not 2018 immediate concern, the issue that’s going to become much more acute, because it is political, financial, and economic all wrapped into this one area of Italian banks.

ZETTELMEYER: Isn’t accelerating clean up a good thing?

REDIKER: It is a good thing in the longer run. I’m not saying it doesn’t need to happen. The position I’ve advocated is while I mention that window in which Germany and other companies were allowed to use state aid to recapitalize and put their banks on a steadier footing, that window is closed. And so the question is, can you reopen it? They’ve already done it through some tortured interpretation of the existing rules for two or three smaller banks. Now the question is, can you do it for the banking system as a whole, letting Italians use their own taxpayers’ money, not asking for German bailout. But more flexibility in the application of how the Italians use their own taxpayer funds to stabilize their own banking system. And right now that is, as you know, not allowed under the rules.

MALLABY: We could sustain this for a while, for I want to see—you’ve got your issues, but what about the members of the—of the meeting here? So we’re going to go to you. Remember that this is on the record. Please wait for the microphone and speak clearly into it. I see Larry Meyer right in the middle there. Just—the microphone is coming. And for the record, please say who you are.

Q: OK. Larry Meyer.

So, Caroline, I want to stand up for the U.S. recovery. (Laughter.) I give it much higher mark. I’m surprised you don’t. And for Douglas, I want to stand up for inflation risks. So let me just make two quick points. How can you say it’s a disappointing recovery when the unemployment rate fell from over 10 percent to 4 ½? What that’s telling us is secularly we’re a low growth economy all around the world. Sorry, not good for my grandchildren. OK, but you judge the recovery by how fast the economy is growing relative to that potential. It’s doing very well. It’s a very nice recovery. Could have been a little stronger in the beginning.

With respect to inflation, do you know what inflation was in January and February and since August, on a 12-month basis? One-point-eight, 1.9 (percent). We don’t know why it’s so low now. But let’s just say, it’s not unreasonable—it’s what the Fed thinks—it’s going to be 1.8, 1.9 next year. What’s the unemployment rate going to be? A percentage point below the NAIRU. Start to worry? Well, downside risks in the near term, upside risk for inflation. And then throw on top of that fiscal stimulus, oh, too much of a good thing.

MALLABY: So we know how you would be voting if you were still on the FOMC. (Laughter.) But this is basically saying we’ve moved from secular stagnation into kind of Goldilocks. In other words, you know, nice growth, above-trend growth, inflation still under control. This is the Goldilocks scenario we had in the late ’90s. That’s what you’re—that sounds like what you’re saying, is that right?

ATKINSON: I thought he was saying that secular—

Q: (Off mic.)

MALLABY: Oh, worse than Goldilocks.

Q: (Off mic)—challenges because, as you say, rates are so low. Monetary policy is less effective than it used to be. God knows what happens with fiscal policy. You know, I don’t look at this as quite a Goldilocks economy when we’re growing at 3 percent and inflation was 2 percent.

ZETTELMEYER: But we have a perfect fit, right, that’s going to basically keep the current course. So if there’s fiscal stimulus—and, again, you know, I disagree with how the fiscal stimulus is made—all that’s going to happen is that, you know, the roles—relative roles of fiscal policy and monetary policy are going to become more normal, and anything that you think creates inflation risks will be offset by reducing monetary stimulus. So where is the problem?

Q: Well, you’ll have to raise rates very rapidly under those circumstances, which are kind of in a(n) uncertain period under those circumstances.

ZETTELMEYER: OK.

Q: Let’s just say a lot of political pushback. (Laughter.)

MALLABY: Let’s take another question. There’s one right in the back, in the middle.

Q: Jeremy Young. I’m a journalist with Al Jazeera.

I know the story just broke, but I’d love to know what you think about the Paradise Papers. So these are confidential financial documents that were leaked from a firm based in Bermuda that specializes in tax avoidance schemes. I’m curious what’s jumped out at you so far. And I’m also wondering if you think getting these types of documents into the public domain could possibly trigger, you know, medium- or long-term changes on the issue of offshore tax avoidance.

MALLABY: Whoa. I have no idea. Would anyone like to comment? This is for Doug. (Laughter.)

ATKINSON: It’s a Doug question.

ZETTELMEYER: If all else fails, it’s Doug.

REDIKER: I think I need to find a Doug. OK, I haven’t had the opportunity to read anything other than the headlines, so I don’t have any particular insight. I mean, anything that is a tax avoidance scheme, that breaks either domestic or international law, you know, ought to be shut down. I mean, that’s just a given. Whether increased transparency is something that is a good thing, look, there’s a balancing act, right? I mean, increased transparency that discloses wrongdoing is a good thing. Increased transparency that violates the expectations of privacy is at least, you know, if not an outright bad thing, it’s not an expectation that we should be encouraging. So I don’t have a view on the specifics but, you know, I don’t think these are easy issues. But obviously, the starting point is, you know, if you’re exposing wrongdoing, then the underlying wrongdoing is probably, you know, by definition something that should be stopped.

MALLABY: Let’s have a question from here. Yeah.

Q: Hi. I’m Nilmini Rubin with Tetra Tech.

I was wondering if you could talk a little bit about China, growth in China. What does that mean for the U.S.? Is it going to rise all of our boats? And then if you could break it down, not just the U.S. generally—but, you know, earlier the issue of inequality came up. Can you break it down a little bit by the segments of the U.S. population, how does the rise of China affect people in this country?

MALLABY: OK, so China and its impact on inequality. Caroline, you raised the issue.

ATKINSON: Well, I think that—I generally think that if China is growing more strongly and China’s economy is stronger, that’s good for its—it’s the second-largest economy in the world, so that’s good for the rest of the world, as a sort of first principle. It then depends on the basis of what is China growing. And I think what’s interesting—and we were discussing this before—is that the Chinese leadership has just made clear that they are actually moving towards focusing—even further towards focusing on the quality of growth and not the quantity of growth. So I think that it would be very good if China does pursue a shift form investment and export-led growth to more consumer and consumption-based growth. If they succeed in doing that, that will tend to encourage more imports into China as well, which will benefit the global economy, including the United States, more than elsewhere.

On the inequality point, others will have more data, but obviously the entry of China into the global economy, both through the WTO but also through their changing positions in the ’90s and 2000s, one can argue had an impact on the relative cost of labor. But right now I don’t think that’s the—or looking ahead I don’t think that’s the issue for the United States economy, and China is more competing in other areas. And so I don’t think that there’s an inequality story really coming from the future of China’s economy.

MALLABY: Mike.

Q: Mike Mosettig, PBS Online NewsHour.

Doug, could you go into more detail about where you think the Senate is going to be worried, which provisions of the tax bill? Are they more serious than the House about the deficit? Although it seems like when anybody ever gets into office they cease to be serious about the deficit. So if you could just elaborate more on where you think the Senate traps are on this bill.

REDIKER: So, again, I haven’t sat down and read through all of the 486 pages and gone provision by provision, but I think that the—the second part of your question is the right thing to focus on, which is the House, for whatever political reasons, including the tea party, has decided that all of that there shall be no deficit stuff was somehow overtaken by events. The Senate, by virtue of the fact that, first of all, they’ve got this very slim majority, and through reconciliation means that they can only lose three votes, you’ve got a number of senators who have either decided to not run for reelection or have otherwise dug their heels in on the budget—the deficit issue. And how you calculate that 1.5 trillion (dollars)—only in Washington can a $1.5 trillion deficit be considered neutral, but that’s a different issue. So even if you assume that, that assumes a lot of financial engineering to get to that figure, and it assumes a lot of inputs that don’t change, and the temporary nature of one versus the permanent nature of the other.

You’ve got people like Collins who have expressed publicly some concern over the estate tax, which I’m led to believe is something near and dear to the White House heart. You’ve got a number of senators who are saying 1.5 (trillion dollars) is a line in the sand—including Senator Corker, who, of course, has made his views of this administration clear. You’ve got Senator Flake. You’ve got a number of others. You had Lankford over the weekend come out with a surprising statement that was not so uniformly or unanimously supportive of whatever comes through.

So, as these things trickle out, you’re going to see individual provisions that run afoul of individual senators’ and members’ ideological or political interests, and all it takes is three in the Senate. You had 20 people—20 Republican members in the House who did not support the budget resolution and, you know, they could only spare 24. So, you know, let’s see. Let’s see. But I can’t point to specific senators and specific provisions that are going to run—make it run afoul. I think that that’s just a work in progress.

MALLABY: Doug is unique in quoting four different senators and saying he can’t point to specific senators. (Laughter.)

Yes, right here. Yeah.

Q: Jim Jones.

Ms. Atkinson raised the issue of NAFTA. I would like to pursue that in a little more detail. My theory is that NAFTA’s fate depends to a large extent on the tax bill, and the reason Lighthizer really pushed the Mexicans and the Canadians to extend for another quarter was to give the tax bill some chance of passing. If it doesn’t pass, I think then Trump just automatically withdraws from NAFTA. If it does pass, I’d say it’s 50/50 depending on how he wakes up any particular morning.

The question I have is—well, the statement I have is—I think Canada will survive it reasonably well. They’ll go back to their bilateral. Mexico will survive it reasonably well after a short-term blip, with diversifying their supply chains, diversifying their markets, et cetera. But what will happen to the United States? Obviously, it’s a—it’s a relatively small part of our economy. But let’s say he announces the six-month timeframe and he’s going to withdraw. It doesn’t mean he’s going to withdraw after six months; he can have some other time. But what do you think would happen to the U.S. economy if he makes that announcement?

ATKINSON: Well, I think—I mean, the others should weigh in.

But just on a—there would obviously be consequences for different industries. And going back to Sebastian’s question about confidence, I think that could have an impact on confidence.

With many of these things it depends on how sudden something is. So if it’s well-signaled, which I guess one could almost say that it has been so far, that may—and to happen over a period of time—then I guess there will be adjustment that will be less dramatic.

But what do you think?

REDIKER: So let me—let me push back on two premises of the question.

First is I could make a case for the opposite outcome, that if the tax reform bill does not go through that the Trump administration, showing zero legislative accomplishments in their first 15 months in office, would basically—could consider accepting the modernization part of NAFTA without the completely overhauling NAFTA parts. So they’ve already basically agreed on taking a number of chapters from the TPP that were already agreed between the U.S., Canada, and Mexico. That part is really pretty non-controversial. If in an extreme case, where the Republicans are proving themselves totally incapable of governing, if that’s the narrative, one could make a case—I’m not saying this is my view, but one could make the counter-case that they pass NAFTA because they have nothing else to show for it.

The second thing is the withdrawal of NAFTA is a six-month notice that allows you to, but does not compel you to withdraw. But even if you try to withdraw, there’s certainly a lot of constitutional law scholars who are arguing that the various implementing legislation and trade legislation are in conflict with the NAFTA provisions, so that the president could not actually withdraw from NAFTA without congressional—affirmative congressional action. So that’s, I think, going to end up looking a lot like immigration, where it’s going to be fought through the courts and you’re going to have various confusing issues for possibly years to come.

The question will be: How does investment and business activity respond to this hobgob (sp) of, well, we think we’re withdrawing, but we’re not sure we’re withdrawing, and it’s going to be some district court that’s going to go up to the Court of Appeals that’s going to be pending before the Supreme Court for years to come? I’m not sure that happens.

But the other point is Mexico has already said if the U.S. does—or does trigger the withdrawal, they’re walking away because they’ve got their own domestic political issues in 2018. And I think that’s going to just be a stalemate for 2018.

MALLABY: Microphone just coming.

Q: I was surprised that Brexit didn’t come up, other than Doug saying at the last minute no one’s talked about Brexit. And it appears to be a slow-motion train wreck. It may not end up that way, but that is probably the best bet. Can you comment on what you think the impact would be of Mrs. May continuing to muddle along toward what is likely to be a hard Brexit dropout? Or maybe you may disagree with that, but what is going to be the impact over the next 18 months on Brexit?

MALLABY: Well, I’ll give you my two cents, having just come from Britain yesterday.

You know, it seems to me we’re reaching a point where the leadership of the Conservative Party understands that there’s just simply no way they can negotiate a new deal in the two-year timeframe. Before they pretended they could; now they’ve given up pretending. And that’s because even negotiating the first stage, which is the amount that Britain pays as a sort of exit settlement has taken a very long time. And it’s taken a long time partly because Germany has a sensible strategy, from a German point of view, that the first stage of the negotiation when you’re talking about Britain’s payment, the EU 27 will be totally united—they all want more money. When you move into a next stage of the negotiation, which is what the—what the trade arrangement looks like after exit, then obviously the Poles feel different to the French feel different to the Germans, and you end up with a disintegrating cohesion on the—on the European side.

So it’s been dragged out, and that’s made the penny drop that this simply won’t be concluded. So, therefore, there will have to be a transition arrangement at the end of the two years, beginning in March 2019, and that is now acknowledged. But doing what it takes to get the transition is not something that people want to—in the government want to accept, what that implies, because you can—you know, it’s possible that the Europeans will negotiate a bespoke final settlement for Britain, but it’s not going to negotiate twice. It won’t do that for the final settlement and do a bespoke transition agreement. So transition really, really has to mean the Norway option, where you continue to pay your dues to Brussels, you continue to accept European Court of Justice oversight, you continue to accept labor mobility. I don’t see any other way you get a transition.

But the Conservatives can’t admit that because that’s political suicide. So it looks as though this is going to be dragged out until we’re much closer to the March 2019 chasm, at which point probably the government will blink and say, OK, we really need that transition deal; we’ll have to just do what it takes to get it.

There are kind of minority theories around that central thesis. You know, one is that somehow the Conservative government will fall. It has a very small majority. It has to rely on these dubious Northern Irish types for—to keep the coalition together, and the sex scandal in the last week has triggered a couple of by-elections already. And that—you know, the majority is so flimsy that perhaps the government could fall early, and then you might potentially get an election, a Labour government, a new referendum, who knows what.

The reason I find those, ultimately, to be the sort of—not the central forecast is that if you’re a Conservative member of Parliament, you know that allowing Theresa May to fall invites an election which you’re going to lose against Jeremy Corbyn. So it seems to me the self-interest of the Conservative MPs lies in keeping her in office for now.

Q: And possibly Labour as well.

MALLABY: Anybody want to add, comment, disagree?

REDIKER: Well, the only point I would add is it is astonishing, if you go to Europe and talk to officials, how limited the conversations is about Brexit. Whereas, of course, if you’re in the U.K., it’s, you know, basically existential. And that dichotomy is, I think, expected to those of us who’ve watched it play out fairly acutely watching it. But I think it’s been a surprise to the U.K. that, you know, in Brussels they’ve got a team working on this. It’s a big team. And they’ve moved on to the post-Brexit EU 27, and that’s complicated enough, as we were discussing earlier. It’s not all about Brexit. But in the U.K., it’s all about Brexit, and for a reason.

MALLABY: Yeah. In the German election, Brexit was hardly an issue.

ZETTELMEYER: But, I mean, you are really placing a lot of weight on the electoral rationality of the Tories here, no? I mean, so the notion that you might get, you know, a bunch of Euroskeptics that say no way and defect if this is the type of transition arrangement that they are offered is, I think—I would be quite scared by that if I were Mrs. May.

ATKINSON: That sounds more—that sounds quite likely to me. And it’s sort of interesting if you think of the United States, where people might have expected more Republican opposition to the current leadership, and that’s actually been very limited, pretty limited. Whereas in the—showing a sort of desire for survival, you might say. (Chuckles.) In the U.K. I think that’s not so obvious, partly because this schism in the Tory party is something that is very, very deep.

ZETTELMEYER: The whole Brexit—the whole Brexit decision in the first place was irrational, right? So they have already demonstrated they are willing to take all sorts of risks to make this identity point, so why should they be—(laughs)—any of them be very different when it comes to, you know, deciding on the transition?

MALLABY: Here we see an example of the legitimate exasperation—(laughter)—on the part of continental Europeans with respect to Britain, which is another reason why the negotiation isn’t going so well. Utterly justified.

I think we have got time for one last. Yes, let’s go in the back.

Q: (Off mic)—very much for this. Rich Miller at Bloomberg.

What are the implications for asset prices of running the economy hot? And shouldn’t the Fed, or should the Fed, be taking account of that, number one?

And, number two, it seems like over the next four years there’s probably not an unreasonable chance we’re going to have a recession, and it’s going to be a recession that’s going to come with interest rates at very low levels. If you were advising the new chair, what would you tell him that he should be doing or thinking about now to prepare for that? Thank you.

ZETTELMEYER: I can say a sentence on that.

MALLABY: Yeah. Go for it, and then we’ll go down the line.

ZETTELMEYER: So I think it is a concern, and that’s part of the—

MALLABY: Which bit? Which bit? The asset prices?

ATKINSON: Asset prices?

ZETTELMEYER: Running asset prices hot; the, you know, financial stability consequences of very easy monetary policy. And that’s one of the reasons why I argue that you ought to have some rebalancing in the direction of fiscal policy.

MALLABY: Anything?

REDIKER: I’m going to defer.

MALLABY: OK.

Caroline?

ATKINSON: I agree with Jeromin, yeah.

MALLABY: So more fiscal stimulus, less monetary stimulus addresses some of the concerns here on asset prices. OK.

Q: (Off mic)—the zero lower bound. (Off mic.)

MALLABY: Yeah, I mean, this issue about the zero lower bound always seems confusing because, you know, you can argue it either way. If you’re worried about the zero lower bound, it means you want to avoid a recession, so you might run policy loose to keep growth up. Or you could argue you want to get off the zero lower bound so you want to raise rates faster, but then you might get that recession. So I’m not sure if there’s—I’ve never really understood the force of that. It seems to me the zero—I mean, the proximity to the zero lower bound doesn’t tell you anything either way about whether you should be more hawkish or more dovish would be my view.

ZETTELMEYER: I wonder whether Stan Fischer could comment on that point.

MALLABY: Stanley’s been hiding. (Laughter.)

Q: Waiting to hear your views. (Laughter.)

MALLABY: OK. Well, I think—I think we’ll wrap it up. Thank you very much to everyone for attending. Thank you to Caroline Atkinson, Doug Rediker, and Jeromin Zettelmeyer. (Applause.)

(END)