Essential Perspectives on the Fed, Inflation and Economic Crises

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• What can we learn from the past that can help us understand our economic world today?
• Economics professor Barry Eichengreen is a scholar of the Great Depression; the global economic crisis of 2008-09; and the history of economic policy in the U.S. and beyond.
• Barry talks with Alan Dunne about parallels between the 1970s and today, as well as his thoughts on recent signs of an economic downturn.

When Barry Eichengreen was a young economics student, international economics wasn’t widely studied or practiced in the United States. 

“Globalization was not yet a thing,” says Barry, who serves as the George C. Pardee and Helen N. Pardee Chair and Distinguished Professor of Economics and Political Science at the University of California, Berkeley. 

“But I’m a first-generation American. My parents came from Europe. … By virtue of that, I became aware of the fact that there was a big world out there at a relatively early age.”

Although Barry doesn’t mention it in his conversation with Alan, it’s worth noting that his parents were Jewish immigrants who met in America after World War II. His mother, Lucille (Landau) Eichengreen, was a survivor of the Łódź (Litzmannstadt) Ghetto and the Nazi concentration camps of Auschwitz in Poland, and Neuengamme and Bergen-Belsen in Germany. She wrote a memoir detailing her experiences and frequently lectured on the Holocaust in the U.S. and Germany.

It seems natural, then, that Barry became a student of history.

“I think it’s useful for people, if they want to become scholars — or for that matter, anything else — to find their niche, to figure out what they’re good at,” he says. “And I figured out pretty rapidly that there were other economists who were better at math than I was, but that I could mine the historical angle better than they could. So it was partly a matter of calculation and partly a labor of love.”

Alan Dunne sat down with Barry for another installment of our Global Macro Series on Top Traders Unplugged to talk about learning from economic history to better understand our current challenges. Barry reveals his long-term predictions about the strength of the U.S. dollar, especially in comparison to the Euro and the Chinese Renminbi, and his opinions on rising public sector and private sector debt. 

Below we share highlights of their conversation on monetary policy then and now, as well as why Barry thinks the Fed is “behind the curve” on inflation.

‘Open mouths’ and ‘open markets’

Barry has published widely on economic history and the international financial system. His books include “Hall of Mirrors: The Great Depression, The Great Recession, and the Uses — and Misuses — of History,” “The Populist Temptation: Economic Grievance and Political Reaction in the Modern Era” and “In Defense of Public Debt” (the latter co-authored with Asmaa El-Ganainy, Rui Esteves and Kris James Mitchener). 

Alan thinks that after the global financial crisis, some in the finance world grumbled that “economists, equipped with their mathematical models, hadn’t really learned the lessons of history.” Whether or not that rings true, one of the hallmarks of modern life does seem to be a short (or selective) memory of past crises. 

So he asks Barry: “When we look at economic history, how much can we expect to learn — and how clear do you think the parallels are at any given time?”

“We can inform our use of current monetary and regulatory policies better by looking at what happened in the 1970s and 1980s,” Barry replies. 

“But the conduct of monetary policy now is different than it was back then. Forward guidance is better developed. Central bankers believe in open-mouth operations as well as open-market operations, and they do more to try to communicate to the markets.”

In other words, the Fed uses its media platform to quell investors’ fears (or prepare them for a downturn).

Plus, today’s open-market financial system is much more complex and diverse than the largely bank-based financial system of the 1970s and 1980s. 

“I do think we’ve learned important things from that experience,” he adds. 

Low rates can avoid an ‘inflationary trap’

Barry recalls that Arthur Burns, the Fed chairman from 1970 to 1978, “denied the idea that monetary policy was capable of taming inflation.”

But “we’ve moved beyond that misconception,” he adds. 

Case in point: Paul Volcker tried to raise interest rates three times before he finally succeeded in ending inflation back in the ‘80s, partly because of concerns that higher rates cause something to “break” in the banking system. 

Barry says the inflation problem only got worse as a result of Volcker being “too quick to relax.” 

In the 1990s and early 2000s, Barry saw the Fed behaving differently — “continuing to tighten, albeit at a slower pace than before, and using non-interest-rate instruments to deal with systemic finance problems.”

Fast-forward to 2008. Barry says central bankers did the right thing in response to the global financial crisis. 

“Then, it was appropriate for them to keep interest rates low, because … slipping into a deflationary trap, into a liquidity trap, was a very real danger.”

Had central banks tightened or normalized interest rates earlier on, deflation would have made the crisis much worse. 

“The Japanese have been trying to get out of that problem for, like, 20 years,” he notes.

Wild fiscal swings

Barry argues that for the last decade or so, U.S. monetary policy was “broadly appropriate” — until the last 12 to 18 months. 

“Clearly, the Fed fell behind the curve,” he says. “They didn’t see the inflation problem. But to be brutally honest about it, most of us did not appreciate how rapid and persistent inflation would become, starting in 2022. We collectively, with very few exceptions, fell behind the curve.” 

The real problem, Barry adds, is on the fiscal policy front.

“Central banks had to keep interest rates so low for so long because there wasn’t appropriate fiscal support for recovery in the 2010s. Too much austerity, if you will. Then in 2021, there was excessive, superfluous deficit spending. The Biden stimulus of 2021 overdid it. Together with the supply-chain, supply-side problems, [the spending] produced near double-digit inflation that we’ve been fighting against since.”

For years, central banks “have been the only game in town” and they’ve had to “mop up problems created by other branches of government,” Barry notes. He thinks that for the most part, they’ve done that pretty well. 

“But monetary policy cannot solve all problems,” he warns.

Like a virus, bank runs can be contagious

Alan observes that we’ve been in a tightening cycle for a while, and ostensibly, “central banks will keep tightening until something breaks.” 

In recent weeks (just prior to this conversation on April 5, 2023), Alan has noticed “signs of things starting to break.” 

Like a bank collapse, perhaps?

So he asks Barry — as a scholar of the Great Depression and other banking runs throughout history — whether he’s worried about what we’re seeing in markets at the moment.

“I am worried. Because I think we’ve seen a demonstration of the power of contagion,” Barry replies. “Contagious fears of depositor runs and the like have leaped across the Atlantic, all the way from here on the West Coast to Switzerland and, to an extent, Germany. Banks that look well-capitalized one day can be in serious trouble the next if there’s a collective loss of confidence in their business model. We call that a depositor panic.”

We’ve seen all too vividly how that kind of panic can unfold online — in chat rooms and webcasts, if not in more public arenas like social media. That’s why Barry thinks “there’s good reason to worry.” But we also should be reassured by the response from policymakers. 

“In Switzerland and the United States policymakers can be criticized for many things,” he adds. “But they cannot be criticized for responding too slowly or cautiously.”

He praises how the FDIC and FINMA (the Swiss equivalent) moved decisively to guarantee deposits and to force “shotgun marriages” between failing banks. 

“All of which, for the moment, as you and I speak here today, seems to have gone a long way towards stabilizing the situation [and] restoring confidence,” says Barry. 

“We’ll have to see how durable that restoration of confidence turns out to be. But this is not a time either for the regulators or for innocent bank depositors like you and me to let down our guards.”

That’s why we make Top Traders Unplugged: Confidence requires vigilance.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.