Why Central Banks Are Losing Control of Inflation ft. Manoj Pradhan

[00:00:01] Manoj

And that has implications not only for where interest rates will have to go, not only for how central banks will have to think of inflation, but also for the size of balance sheets, which is a huge question with the incoming chair, Warsh. I think it’s a very, very complicated situation for central banks in the future.

[00:00:20] Intro

Welcome to Top Traders Unplugged. In markets success doesn’t come from predicting what happens next, it comes from being prepared for what you can’t predict.

In each episode we go deep with some of the world’s most thoughtful minds in investing, economics, and beyond to understand how they think, how they prepare, and how they decide, and the experiences that shaped how they see the world. No noise, no short-cuts, just real conversations to help you think better and invest with confidence.

[00:00:53] Kevin

Welcome everyone to Top Traders Unplugged.

My name is Kevin Coldiron and I’m host of the Ideas Lab series where we talk with authors of new books that help us understand the global economy and where it’s headed. Our guest today is Manoj Pradhan. Manoj is founder of the Economics Consultancy Talking Heads Macro. He previously worked at Morgan Stanley, and he is the co-author of a new book, the Unanchored Central Banker: Demography, Fiscal Instability and an Erosion of the Central Bank’s Inflation-Fighting Ability.

Now, if you’re a longtime listener, you’ll remember that he was also a guest here exactly four years ago to talk about his book The Great Demographic Reversal. In that book he predicted that a reversal of several long-standing demographic trends was going to result in higher inflation, a pressure toward higher interest rates, and growing fiscal deficits. Since then, many of those themes he identified have intensified and have become part of the mainstream economic discourse.

So, if you listened then you are ahead of the game. And if you’re listening now, you’re also going to get a head start in understanding why central banks, in the future, are going to struggle to contain inflation.

Manoj, thanks so much for joining us and welcome back to the Ideas Lab.

[00:02:14] Manoj

Kevin, pleasure to be here. I enjoyed the conversation the last time. Looking forward to this one.

[00:02:19] Kevin

Excellent. Well, I do want to mention that this book and your previous book are co-authored with Charles Goodhart, the well-known and very well-respected economist. So, it’s important to say that.

Let’s start today, if we can, by just reviewing a few of the themes from your first book so we can kind of set the stage for people. Now, in that book you identified important demographic trends related to baby boomers, women entering the workforce, and China being integrated into the global economy. I was wondering perhaps if you could just summarize what those trends were, why they were so important to the world that we’ve been living in. And then we can talk about, you know, how they’re changing.

[00:03:05] Manoj

Well, first, top marks for memory. It’s fantastic. Absolutely right. Those three forces and the zest they created for globalization essentially created what we call a demographic sweet spot. And the result of those three things was an abundant supply of labor, particularly from China, that lowered the cost of labor. They moved capital away from the western economies and into China to take advantage of domestic cost advantages there.

And by reducing the desired capital in the advanced economies, particularly the United States, which sets the interest rate, you were able to bring down not only the cost of producing goods, goods inflation, wages, and therefore nominal interest rates, but also the real interest rate. Because EXANTE investment falls relative to savings in the West, real interest rates are set off that. And so, the equilibrium interest rate also comes down.

And the result was really a worldwide positive labor supply shock and a boom, the kinds of which we really hadn’t anticipated before, coming from a source as big as China. So, you had this fantastic period in which central banks literally had tailwinds that they had never seen before. You had falling inflation. The falling inflation and interest rates allowed people to borrow. It made people more willing to lend. House prices did very well.

Even if you had large increases in government spending, because interest rates were falling so much, the cost of financing that debt was extremely low. And as you can see, in a positive labor supply shock or a positive supply shock, growth does very well, Inflation comes down. What’s not to love?

And one of the key features of that landscape was because central banks were able to help generate an environment in which the incumbent government found it easy to get reelected, the governments themselves were more than willing to give central banks as much independence as they needed. And that real sense of cooperation is what drove financial markets and growth into a period of real stability, a real boom.

And we believe, as the demographic reversal now turns, it’s unreasonable to think that all of those forces, to the extent that they had been pushed by demography, can survive. And that’s really the gist of the great demographic reversal.

[00:05:36] Kevin

It’s interesting you talk about the relationship between governments and central banks in this period, and we’ll get to that later, but it’s almost like you’re describing the honeymoon period of a marriage, right? Everything’s great, there’s nothing to trouble you.

And really now we’re talking about the marriage being a decade or so in and issues are arising, and there’s going to have to be negotiations and a more back and forth. But before we get to that, let’s talk about why those forces are reversing. Right?

So, we had this labor supply shock, baby boomers entering the workforce, women entering the workforce, or participating in the workforce at a much higher rate before, and then China. So, what’s happening with those three themes now? And what do you expect going forward? Why are these reversing?

[00:06:28] Manoj

I like this question a lot. The reason is because most questions that we tend to get tend to focus on the end result. And I think you’re getting to the crux of the demographic issue over here. So, there are a few things, and let me work through those.

The participation of women in the labor force, particularly in the Western economies, really changed in the ‘30s and the ‘40s. So, before that, as custom would have it, most women were almost thought of as being primarily responsible for housework. And so, once the advent of household appliances really took hold of the economy, the traditional role had changed without traditional thinking really changing. And that allowed women to start participating to a greater extent in the workforce.

And then over time, the traditional role and the traditional thinking around women’s participation in the labor force has turned around completely. Well, I shouldn’t say completely. There’s still progress to be made in many fronts, and particularly in emerging market economies where their participation still lags. But in the advanced economies, their participation rate has gone up pretty close to being on par with men. It’s not exactly the same.

And in fact, in some sectors like healthcare, education, women’s jobs are far better protected than men’s jobs in more cyclical environments. That’s one. The second one, I think, is a question of baby boomers. I think that part is really very well understood.

You had a generation in which the baby boomers really came into the labor force and provided a huge domestic boost in labor supply, the likes of which I don’t think we’ll get for a very long period in time, if ever again. And the biggest one in that category was actually the integration of China and Eastern Europe, but particularly China.

What China brought that was very different was it had a relatively skilled to highly skilled workforce that it could integrate across all levels in the global economy. Not only did it have workers with lower skilled, but it had workers who could compete in manufacturing. They had workers who could compete at the very highest levels of technology generation. And you’ve seen the progress that they’ve made in different fields.

So, when a workforce like that joins the global labor force, the supply shock is felt across a range of products. But in that period, it was particularly in manufacturing. And obviously, it’s very well known that China’s labor supply is now dwindling to the extent that cities within China themselves are in intense competition for the next round of migrant workers. So, the transformation within China is also quite mature.

And there are questions about urbanization and whether urbanization has reached what economists like to call the Lewis point. And the Lewis point being the point at which further immigration actually damages the economy. It’s not clear that they have. But the very fact that you’re having that discussion just shows you how mature the process of urbanization through migrant worker flows has been.

So, in all three or four aspects, we’ve reached a level with those forces that don’t look like there’s that much more upside. And if I may, there’s one final piece of the puzzle for demography that really bears mentioning, and that’s immigration. So, after the pandemic, one of the things that we didn’t anticipate is a worldwide, not just American boost in immigration, which really fed into labor supply very aggressively. It’s well known that they created extra demand for rents, extra demand for consumption. And in many economies, that has now created a social and political backlash, not just in the US, not just in the UK, but everywhere else as well, to the extent that many economies are now seeing a very sharp slowdown in immigration.

And it’s very difficult to think that the change in the atmosphere surrounding immigration is going to change in the foreseeable future, which means external labor supply, itself, is going to be weak.

[00:10:31] Kevin

Yeah, that’s an important point because, as you work through the logic in your book, a lot of it has to do with, well, we’re going to have a “labor shortage”. And obviously the immediate thought, as well, is that you can import labor. You can import labor from places like Africa where there isn’t a labor shortage. But of course, that route, I don’t know if it’s shut off permanently. I doubt it is, but it’s certainly, in the near term, not likely to be a release valve. So, that’s a great summary for how things have reversed.

Can we talk about one of the kind of underlying forces certainly behind, say, the baby boomers and also impacting China, which is just the birth rate? I remember when we spoke four years ago, you were talking and you had some great charts in your book about how the birth rates were falling all over the world, and you said hey, even in India there are some states that have a birth rate below replacement rate. And to me, I was like, wow, that’s. I, you know, because I guess had a somewhat outdated view of India having kind of growing population.

And you were like, well, you know, at the country level it’s still above replacement, but if you look at state by state, some are below. And now I think, even at the country level, India is below replacement rate.

So, could you maybe just summarize where we are with global birth rates relative to, you know, that replacement rate of 2.1? And do you anticipate any more surprises? Surprises have all been on the downside in the last four years.

[00:12:15] Manoj

No, I think you painted the picture very well. I think, with the exception of a handful of economies, and predominantly some of those include sub-Saharan Africa, most economies are below the replacement rate, and 2.1 really being the magic number (the .1 is obviously mathematical), but most economies have fallen so sharply below that it would take a real change in social, economic, and political conditions to get that up.

There are reasons behind that, the first of which has been an unwillingness of many families to have large families – households to really have large families. Some of it in the emerging market economies has to do with the cost of living. But primarily large families in less developed economies used to be because fertility rates and morbidity rates among young children were unfortunately very, very, very high.

So if you had, in India, for example, 30 or 40 years ago, if you had a large number of children, the chances of some of them surviving into a ripe old age would be that much higher. That has changed. So, some of the improvements in health conditions have made it less necessary for families to have more children.

What’s more interesting, I think, is research, for example, one of the charts that we present in our book, by Geruso and Spears, talks about the reasons that you see less women having children. And partly that does have to do with economic conditions.

The UNHCR report on fertility also reinforces it, that across a range of countries, one of the prime reasons that families, young families are not having more children, or some are not having as many children at all, is related to the cost of raising these children. Could that change over time? Could you get a massive positive surprise? Well, that’s been tried.

Hungary has had a program that has tried to encourage childbearing. China very recently came out with a fairly large size package that would give help to young families, and ones trying to have more than one child. They haven’t really borne any success. And part of that points to some of the other constraints around having children.

A lot of women who naturally, in a continuation of your earlier question of women’s participation in the workforce, a lot of women also argued that having more than one child or more than two children severely inhibited their ability to have strong careers because it would mean a disruption.

And now, again, there are some solutions for that. In Norway, for example, the benefits, in terms of leave that a young father gets, are almost the same as the one that a young mother gets. So, they’re able to participate a little bit more in family rearing. But that hasn’t really changed the entire picture.

It’s possible that you could have an increase in the number of children, but to be honest, I find it difficult to see how you could generate it across such a large number of countries, which have all seen a downtrend in childbirth. It seems very difficult to reverse it. Maybe a possible modest improvement, but something that gets them above 2.1 looks incredibly difficult to me.

[00:15:36] Kevin

Yeah. By the way, I wanted to say I appreciate how you do this multiple times in the book where you say, okay, here’s the demographic trends that we know, and we know what their impact is going to be, and then here are some possible things that might offset it. And so, you’re very good at saying, well, on the one hand, this is what we know is going to happen. On the other hand, this could happen.

So, if we have to balance fact with hope, we’re going to be on the side of fact and not put too much emphasis on something that might happen, even though it’s possible. And we’ll see that again when we talk about the impact of artificial intelligence on the labor force.

So, you look at these demographic trends, and you draw some important conclusions. And one of those important conclusions is that you expect real interest rates to be higher. And this is an area where, I guess, conventional economic thinking has what you call blind spots. They might agree there’s going to be, say, a worsening dependency ratio, i.e. fewer workers relative to those who aren’t working, but they don’t see a path from this to higher rates, whereas you do. So that seems to me quite important. And I’d like maybe if you could just explain what those blind spots are and why, you know, I guess, why you see them and others don’t.

[00:17:03] Manoj

I’d be happy to. This is really part of the reason that we wrote the second book, because in response to our arguments on demography, a lot of models now incorporate demographic pictures about what could happen to real interest rates, what could happen to other parts. Unfortunately, I would add, because it becomes important later on when we discuss inflation and we discuss fiscal policy, as I’m sure we will, that they do not yet incorporate one of the most important messages from our first book, and again, in the second one, which is health care and looking after the elderly. Because we haven’t reached a critical mass of elderly people in many Western economies that is not yet thought about as something that could be a game changer. But if you look at Japan, and you look at the coming demographic change in China, or in the Scandinavian economies, this is quite important. But anyway, I digress. We can maybe come back to that later on.

Let me start with the blind spots argument. So, first, the conventional counterargument to our first book is really interesting and, it actually, on its own, it has merit, even though you can debate it. And the argument goes as follows. The argument says, look, we’re going to live longer, life expectancy has gone up. And as life expectancy goes up, any sane person will tend to save more.

Again, that’s the debatable part because when we look at the data, you look at how much people have saved for the future and you think, well, okay, that’s clearly not enough for the future. But let’s go with the argument that the logic holds. If I’m going to live a longer life and, particularly, a longer period of retirement, I’m going to tend to save more. And that greater savings then goes somewhere to earn some interest, typically into, say, the bond market.

And as you increase those flows into the bond market, you tend to depress the real interest rate. So, the longer you live, the greater your retirement period, the lower real interest rates are going to be. That’s the argument.

It’s very hard to argue with the logic of that. There is a problem. The problem is households are not the only entity that are involved in aging in the economy. The government plays a huge, huge, huge role. And it would be a real blind spot to think that governments will not have to respond to an increasingly aged society by not only increasing healthcare provisions, but by spending more and more on pensions.

And particularly as the comorbidities, including neurodegenerative diseases, take up more healthcare costs, the overall fiscal position of governments is going to worsen. So, on the one hand, you could make an argument that household savings are going to rise if society becomes older.

But there is an undeniable fact facing us that government dis-saving, is probably going to rise even faster.

So, when I put the two together, in our minds there’s no doubt that the net result is going to be that the government dis-saving dominates any increase in household savings. And so, if you’re a dis-saving economy, it’s very, very, very hard to think that real interest rates will remain subdued – just very difficult.

[00:20:10] Kevin

That’s a great, very clear explanation. What about the housing market? Because you say that’s the second blind spot. And I have to admit that one was, I felt a little more complicated, also very important, but a little more complicated to understand. Can you explain that one?

[00:20:31] Manoj

First, you’re absolutely right, it is more complicated because what happens… There are two things, you had mentioned AI before, and we get to discussing that, this will be important as well because housing is something that we all have a personal decision that we have made numerous times, whether it’s in renting, whether it’s in buying, whether it’s selling, whether it’s in mortgage rates. So, we are informed by our own personal data time series.

And then to try and disentangle that from the macro time series or aggregate picture sometimes makes the picture a little muddier. I know this is true for me. It’s probably true for a lot of other people.

The aggregate picture on housing is as follows. There are two or three trends that lead us to believe that housing has often been ignored and really is something that needs to be considered in housing costs. Number one, typically speaking, population growth is the primary driver of homes.

And homes tend to be your largest asset for most families, not everyone, but for most families that tends to be your largest asset. And so, if construction carries on, and the demand for housing continues, we think that puts higher pressure on real interest rates.

Now, one of the reasons, that’s allied to this, that the demand for housing continues in an aging society, is that, from personal experience with my family and from a lot of people we know (and perhaps this is your experience as well), the older you get, the less likely you are to leave your home that you’re living in and move somewhere else. You’re a young family traveling across borders, across city zones. It’s easy. You get a U-Haul. You dump it all in there.

I’ve done it a few times when I studied in the US. Get a few friends, buy them a few burgers, and you’re moved. That doesn’t work for elderly people as much.

I remember, in the last few years my father found it increasingly difficult to leave his room because he was disoriented when he went elsewhere. So, when you pull that together, the fungibility of housing, from the old to the young, falls as a society becomes increasingly aged, which means new family formation depends on new homes being created.

And finally, there’s another trend that has, in some economies, not everywhere, reinforced part of this. In many economies that are rapidly aging, I mean, I can think of Italy for one, Japan for another, China as a third, rural populations and rural homes are dwindling very, very, very quickly.

So, in Italy, there are famous stories about mayors of small towns offering free homes, or you being able to buy a mansion for a euro because there are very few opportunities for the young. And even many old find that access to healthcare in cities is bigger. So, you tend to get a greater concentration in the urban areas where employment is high and social coverage is a lot better. And that means that you do have to take care of an urban population as if the whole economy is growing.

So, to try and extricate housing from a discussion about population growth and changes in these urban/rural trends, again, seems to be a blind spot that people don’t adequately take into account. But I totally agree with you that it’s not as clear cut as the fiscal position. And that’s primarily the one that we focused on in this book.

[00:23:51] Kevin

Okay. And by the way, I am shaking my head as you’re explaining these things, because I’ve experienced them as well. I mean, literally, the street I’m living on used to be every house was full of young children. Now all the young children are gone and it’s people like us, couples with no kids occupying these homes. And I think that’s something that we see, as you said, everywhere.

So, putting those two things together, so we’ve got growing indebtedness from fiscal positions and that, essentially, I think what you’re saying is also, you know, a need to build more houses, a need to invest more in new housing, because of that kind of set of complicated relationships. Both those things are going to put upward pressure on real interest rates (Is that right?) in a way that would be not part of conventional models.

[00:24:53] Manoj

Correct. I mean, just to give you a very quick line, you know, classic models of this genre make the assumption for simplicity. I completely understand tractability in analytical models needs to be pursued so that you can get to the main message. But even in models where you connect demography to household savings and then onto real interest rates, making assumptions that government deficits, debts, and pension are a fixed proportion of GDP just does not work. Because if we are even halfway right, the connection of aging populations to government deficits and pensions is probably far more profound, and powerful, and complicated than it is for the household sector. That’s a real blind spot in most conventional markets.

[00:25:45] Kevin

So, let’s move on to talk about, you know, kind of the implication, potential solutions, and then what you think about the future for central banks where you’re sketching out a world. It’s kind of fascinating, because the discourse right now, the kind of narrative, is all about disappearing because of AI.

So yet, you know, really at the big picture level, what you’re talking about, if we put these demographic trends together, is a shortage of labor – there not being enough workers. So, your view of AI is different or your thinking, I think, about AI is different in the sense that you are wondering, can AI offset some of these demographic trends by replacing labor?

And so, I’m wondering maybe if we could just talk about that, how you think about the potential for AI to mitigate some of the effects of a labor shortage. And again, whether or not that’s enough… or at what level would it take to offset some of these things like higher inflation and higher interest rates?

[00:27:03] Manoj

It’s a fascinating discussion. And honestly, and we don’t and cannot pretend to have any particular insight into how this will evolve, it’s such a nascent technology. I use Claude very, very, very regularly. When we edited the book, the first run we had before we turned it over editor was run with Claude.

A lot of the discussions that I have with people, before I do any of those, I run a lot of programs. I recently built a simulator for fiscal policy that I’m extending to a whole bunch of countries for my own work. And the job was done fabulously by Claude. In fact, it took me 20 times more to make sure the data was right than it took Claude to build the simulator.

I fully understand where that progress is coming from and where the concern is coming from. But we have two or three things that I believe are not in the mainstream discussion.

The first one is the real tail risk, the real negative tail risk of a collapse in the demand for labor. We’ve seen these kind of prognostications before when it came to the Internet, when it came to the industrial revolution, when it came to household appliances, they all said that, look, we’ll see a massive labor demand collapse.

Maybe that’ll happen one day, we don’t know. But if it does happen, I think what the discussion is missing out on is not the fact that there’ll have to be some form of universal basic income. I think that’s fairly well understood, but how you finance those. And I think there were a couple of recent discussions which talked about changing the way taxation is run, in which you don’t yet charge tokens for generating the work of workers. And that’s something that has to be discussed.

But it goes to the point we’re making, which is that if you decide to provide a universal basic income for workers, you cannot finance that by taxing society as a whole. Politically, it would never fly. There’s no chance in that. So, you would have to direct it to companies that have either reduced their workforce by a lot and still maintained profitability or increase their profit share because that would be a very clear signal of labor replacement.

And so, what that would mean is that this huge investment that people make in companies, where they believe labor is just going to collapse, is not the way things will turn out for the stock market if you get a real catastrophic decline in labor demand.

Number two, we argue that the way technology actually affects labor supply is very different. So, David Autor, who’s one of the favorite authors that Charles and I follow for labor economics, he’s made this point. It’s a fantastic point. I wish I had made it, but I’m not that smart, so I’ll quote him. He makes a point that, really, you can relate to. He basically says that in the past, most of the technological shocks that have been, have been to manufacturing. And one particular characteristic of manufacturing is that it tends to be concentrated either in a region (think of Sheffield for steel, Detroit for cars), or a sector for solar panels or EVs and things like that. And so, when you run a shock through a particular part of manufacturing, either an entire geographical region or an industrial sector, they tend to see mass pools of unemployment. And it’s very, very, very difficult to relocate those workers into other jobs or other areas and diffuse that unemployment problem.

When it comes to AI, we argue that the services shock might be spread out a lot more. So, think about, let’s say AI makes 20% or 30% of all accounting work redundant. There’s an accountant in every small town, every village, every corporate entity that exists, whether they’re small, medium, or large. And so, if you cut 20% of their work down across sectors and across the economy, that might make the shock slightly easier to absorb. And that gives us reason to believe that other sectors might benefit. So, for example, you, as a core company, if you have to cut down 20% of your accounting costs, that 20% could go to your core activities.

In a very similar sense, we give an example of what happened when China really affected manufacturing in the world. You did see a sharp decline in manufacturing employment in the US but because, as we described in your first question, inflation went down, interest rates went down, and the global economy did very well, employment in other parts of the economy rose substantially more. New sectors were generated, new jobs were generated.

I can’t, for the life of me, think that I can predict what the job is, but I don’t think a decade ago I thought that you and I communicating on a podcast would be such a powerful tool of communication that would almost outrank traditional media.

And the last point we make is probably our most controversial one. And it has a very unique connection that I think people haven’t really made yet. And it connects two strands of literature. One is on inequality, where we argue that, if you ignore the top 0.5% or 0.2% of an economy, in terms of population, who are probably going to get very, very, very rich because of this, if you look at it as an 80/20, there’s a good chance that inequality actually falls. It allows young companies to do very well. It allows emerging markets to do very well.

And the second strand of the literature is a really interesting paper that was presented, I think, about three or four years ago at Jackson Hole, by Mian, Straub, and Sufi, who argued that the higher the inequality in an economy, the lower interest rates tend to be. And they argued that, because the rich tend to save more, those funds that they save flow into financial markets and depress real interest rates, much like the discussion we had on housing.

So, if you have lower inequality, you tend to get fewer flows of that kind in the financial markets, pulling interest rates higher. That, I think, is a very brief look at AI, but I’m happy to discuss it more if you’d like to.

[00:33:15] Kevin

No, that’s good. You do mention AI reducing inequality, and you seem very confident in that prediction. I think the way you described it also was there’s kind of barriers to entry to higher paid service jobs, accounting, law, etc., and AI removes those. So, it opens up those jobs which are traditionally higher paid to more competition. Maybe there’s fewer of those jobs, but it does, potentially, open them up to more people being able to work in them.

So, you know, kind of just going back to this notion of we’ve got demographic trends creating a shortage of labor and that’s going to be inflationary. And you’re saying that there’s a potential that AI might be able to offset by actually increasing employment in the way that you described. Is that correct?

And I guess you would say, you know, going back to what I mentioned earlier, that while that might happen, you’re not sure, so we shouldn’t bank on it. What we do know is that the demographic trends are going to be inflationary. AI has the potential to offset it to some extent. We don’t know how much. Is that fair assessment of how you think about it?

[00:34:41] Manoj

I think it’s absolutely right. And when you bring in the demographic picture, I think the story around AI widens a little bit more. For example, look at hyperscaler spending this year. It’s breached the US$700 billion mark.

And a big deal about comparing hyperscaler spending now versus the Internet related investment in the 2000s was a lot of that investment previously was based on credit extension. And so, when the Internet story didn’t really go well, the lenders didn’t do very well either.

This hyperscaler spending, a lot of it is coming from cash. But if you take US$700 billion of cash that was resting in a money market mutual fund and now use it for CapEx, you’re almost creating a dual headwind for interest rates.

You’re taking out some of the loanable funds that were supplied at lower interest rates and instead you’re buying capital with them, you’re raising it. Also, interestingly, that’s coming at a time when one estimate of the One Big Beautiful Bill is that, according to the CRFB, it adds US$600 billion to this year’s deficit. So, you’re seeing a net change in the demand for funds by about US$1.3 trillion this year. That’s got to have an increase in real interest rates.

Look at inflationary costs. I mean, you look across emerging markets, you look at Ireland, you look at places in the US, the demand for electricity from AI is clearly going to be a story that changes, hence the demand for data centers and the like, to which there’s social opposition. So, none of these are frictionless problems that AI is restricted to just offsetting labor demand versus labor supply.

[00:36:18] Kevin

I see. Thank you for that. Yeah, that makes sense. So, let’s maybe talk about sort of pivot to talk about the longer-term implications here and particularly on the government deficit. So, you mentioned earlier that unquestionably this is going to put pressure on government deficits.
And then we’ve seen kind of additional things like Trump’s Big Beautiful Bill increasing the debt and the deficit. And we’ve all seen the projections from the CBO that really the US deficits are 6%, 7% for as long as the eye can see.

You do talk about potential things, fiscal moves, that could counter that. And some of them, I think, are really quite interesting. One of them has to do with just, you know, tax incentives for employers to hire people over the age of 55. Maybe you could talk a little bit about what you think that might look like or could look like, because that seemed like quite an easy one to do.

[00:37:24] Manoj

Yeah, I think combined with that is allowing people to choose their retirement age. So, if you combine incentives for people to hire, I mean, this could go towards incentives to hire people with a very fresh college education as well. That’s one of the problems that AI has generated. And on the one hand, when you look at young people, the reason that there’s less demand for them is, while they’re picking up human capital, the company is implicitly financing some of their education. When it comes to older workers, the incentives to hire them actually could be quite varied.

In industries where you need physical bodywork, I think it’s very difficult to incentivize anyone to hire someone older. I mean, I can barely run across a pickleball court for more than an hour and a half. Tennis is becoming cumbersome. And if I play Ultimate Frisbee, it’s only because, you know, it’s a bit of fresh air and the like. So, I can understand physical activity. It’s difficult to do that, but the more cognitive work becomes, the greater experience will count. And that judgment that you have, over years and years of experience, that should make it easier.

So, I think not only could you provide an incentive for firms to hire older workers, you could give them a graded incentive, depending on how cognitive a particular sector is. So, in manufacturing, maybe you could get a foreman who has got decades of experience, and that could be relatively easy to do.

When you combine that with a flexible retirement age, the benefits are that people who believe, and are right, that they can carry on working through the official age of retirement, they get dual benefits. Number one, the more activity you have, the lower your chances are of being afflicted by neurodegenerative diseases. I mean, that part has been proven by many agencies.

And the second part is you could incentivize them to work longer by rolling over their retirement pot at the going interest rate, so you don’t really lose out by anything. And if you want to generate a dual income, not only do you get a labor income, but you get part of the income, that your pension would have generated, rolled over at the existing interest rate for you to bank on when you get there later on.

I think you’re right. I think that’s relatively easy to deliver. I’m surprised more people aren’t talking about that one.

[00:39:49] Kevin

The other one… You mentioned a number of them, including a land tax. But the other tax change that I hadn’t heard of, that I think is certainly going to be more controversial but interesting to at least talk through, is essentially differential tax rates on people with children and without children. And you’re very careful to say there’s no judgment involved here in terms of whether having kids or not having kids is… There’s no ethical or moral point you’re making, but you’re thinking about it purely from an economist’s point of view. So, tell us what your perspective is and how a tax like that might work. What’s the logic?

[00:40:33] Manoj

Well, first, thank you for pointing that out. I’d like to reiterate that this really has nothing to do with the ethics of family. Whether morality, moral questions, judgment, personal choice, whatever it is, people are free to make their own choices. We have absolutely no issue with that. We are only looking at this from a positive perspective. And a lot of it comes from our experience.

I think one of the discussions that we have with people about aging and looking after the elderly is that family tends to provide a lot of the care for aging elderly members. In fact, in our book, we look at statistically how much of elderly care is provided by families, and it’s a huge number.

Now let’s say you’ve got two aging people and you don’t have family members who are able to look after them. That changes the burden of responsibility completely.

If 80% of elderly care comes from within the family, not having one child or having any children changes that dynamic dramatically. And that means you’re essentially shifting the burden of looking after the elderly onto the state or to profit providers.

Now, if you’re fully funded, no problem again. It’s absolutely no issue. If you’ve completely taken care of yourself, either through personal savings, or through retirement benefits, or through healthcare coverage, you have no issue. Our argument is that, in most cases, people haven’t.

And when they don’t take that on, the burden on families with children essentially comes from two ways. Number one is because this is very labor intensive work that AI and mechanization have not yet been able to do. Again, that could change. But if it doesn’t, then you are depending physically on other people’s children in some shape or form to provide healthcare for you or healthcare coverage for you. And second is it’s the children’s incomes that are also paying into the pot that gives you healthcare benefits.

So, our argument is, let’s level the intergenerational playing fields. If you decide to not have children, and again, the question is decide not to have children because we do not want to penalize families that cannot have children or find it difficult to have children. That’s not the intention. For people who decide not to have children, you have a slightly higher tax rate, which is for society to determine. That pool of taxes cannot be used for anything else except paying for health insurance for your own retirement into the future.

If you decide to have children later on or are successful in having children, that is held in escrow for you and is paid back to you whenever you do have children. So, it actually serves as a welcome insurance mechanism, as well, to give you a little bit more of a cash flow right about the time you need it when you’ve had young kids.

We think it’s a benefit that equalizes the burden of debt and responsibility of healthcare across generations, particularly when our society is looking at constrained immigration. In the UK, for example, the hiring of foreign workers for healthcare and for caring has been stopped. At a time like that, the intergenerational burden of care is going to fall disproportionately on families with kids.

[00:44:00] Kevin

Yeah, yeah. It’s a fascinating idea. Essentially, I guess trying to simplify it, it’s like government saying, okay, you probably should save this amount and you’re unlikely to. So, we’re going to force you to put money into a pot and that’ll be there for you. Yeah, I mean, I like the logic and it’s very… It was not an idea I heard of, but I think also, realistically, much more tricky to implement. But thank you for at least putting forward the economic logic.

Let’s talk now about, I guess the title of the book is Unanchored Central Bankers. And when we put all these things together, we’ve talked a lot about demography and the labor force, but at the end of the day, what you’re saying is the impact is going to be this impulse toward higher inflation.

You said right at the beginning we were in this honeymoon period with governments and central banks for 30 years. There were these forces keeping interest rates and inflation low. It was easy for central banks to be independent and left to do their job and say, we’re just going to focus on delivering inflation. That’s going to be a lot harder in the future because of the forces you’re talking about.

So, tell us how you think the relationship between central banks and governments is going to change as we go forward and why you think, in the end, that’s going to mean the end of central bank independence, at least in the way we think of it today.

[00:45:40] Manoj

I’d be happy to. If you don’t mind, I’m going to start from a slightly different point and get us there at the end. One of the things that has really helped the disinflation process is actually out of a traditional central banker’s control.

So, we have a chapter in there called the Two Phillips Curve chapter. It essentially argues that the traditional discussion around the Phillips curve, which is this relationship with that when there is no slack in the economy, and people are working overtime, and you pay them more, inflation tends to rise a little bit faster. And when you’re in a recession, when there’s slack in the economy, inflation tends to fall.

That relationship is actually something that needs to be split in two because there’s one part for goods and there’s one part for services. And the services Phillips curve is really what I just described. It’s a domestically generated driver of inflation that when the economy runs hot, and wage growth is higher, services price inflation tends to rise as well. The other part, which is goods inflation, since the ‘90s has had increasingly little to do with the domestic economies.

Most of our economies are service economies. Manufacturing economies tend to be concentrated in the West. In very few places. Germany has a 20% share of value added from manufacturing, still 80% from services. But broadly speaking, goods prices are determined, I would say, primarily in China and in commodity prices, which tend to be linked to what’s happening within China.

And so, if you look at some of the charts that we’ve provided in there, they show you that the vast majority of economies since the 1990s saw inflation fall because goods inflation fell, because China either had a very benign period or of fantastically low-cost manufacturing or very malign period when their housing markets collapse and inflation collapsed as well. And so central banks have really had to do very little.

They’ve been able to keep their economies and domestically generated inflation quite steady and just reaped a lot of the benefits of having falling goods inflation. Now that story changes. It’s almost like we are splitting history and the future. The disinflation of the last three or four decades came from goods inflation. We don’t think that’s what the future holds.

We believe that the future holds whatever is going to happen to services inflation, and that’s tighter labor markets, more spending through governments, which means tighter is still labor markets, and that means services inflation that remains elevated. This is where the government comes in.

We believe that the government’s ability to curb fiscal spending expenditures is present, but most governments are unwilling to take that extra step. So, for example, take a look at the One Big Beautiful Bill that has passed or the Social Security conundrum in the US, the bulk of the cuts that are baked into The One Big Beautiful Bill will arrive a couple of years from now. Social Security, through its reserve fund, faces a fiscal cliff around 2033.

It’s very difficult to think of the next presidential candidate or whoever is coming in, in the early 2030s, who’s going to allow that to happen because that is a catastrophic political calculus. Which means not only do you get an extension of fiscal spending beyond what is calculated by the CBO right now, you also get an additional constraint that central banks have to deal with. And that’s where the words ‘unanchored central banker’ really comes in.

In the past, for example, take the classic example of Paul Volcker. When inflation started rising first in the ‘60s and then with the oil shock of the ‘70s, Paul Volcker, when he came in, came in and delivered two sharp recessions by raising interest rates to the moon. He was able to do that because there was very little debt in the economy at that time.

So, when you raised the interest rates, there were repercussions for the economy, but not for fiscal stability. You do that with 100% debt to GDP ratio, and if you raise the interest rate to double digits, you will raise the cost of financing debt by a tremendous amount.

Which means, even if you’re able to successfully create a recession, which you will, and bring inflation down today, you have created such a big increase in deficits that then become debt next year, that in order to dissolve that debt into the future, you’ll have to generate inflation in the future. So, you are no longer, as a central banker, in a highly indebted society, able to single mindedly pursue inflation. You will have to take some choice between fighting inflation and balancing off fiscal instability.

And that has implications not only for where interest rates will have to go, not only for how central banks will have to think of inflation, but also for the size of balance sheets, which is a huge question with the incoming chair Warsh. I think it’s a very, very complicated situation for central banks in the future.

[00:50:40] Kevin

So, I believe what your conclusion is, in the end, that central banks are going to have no choice but to maybe not ‘set aside’, that’s not the right word, but when they think about the two competing things of, hey, we’d like to keep inflation under control, but also we need to support the stability of the bond market, that it’s that latter thing, supporting the bond market, that’s going to take precedence. And that, in repeatedly doing that, helping finance the debt, that the inflation objective is going to slip and we’re going to get higher inflation. They can’t achieve both those things.

[00:51:26] Manoj

I think that’s absolutely right. I’ll just quote a few historical precedents to tee up exactly what you said. The first of which is QE. I mean, we got the first QE, and then the second. The economies looked like they were slipping back. You had a QE2, and you had a QE3, and you had a QE infinity.

So, once you introduce a particular tool to solve a particular problem, if that problem doesn’t go away, the market almost makes it inevitable that that tool will be used again.

Second, which is what I think you had in mind, the Truss administration’s experience, the experience of France, the reaction to the new administration in Japan, the reaction to higher fiscal spending in the US, these are all telling you that the days in which advanced economies were given a different treatment than emerging market economies are probably close to coming to an end. This kind of bond market reaction, vigilante is coming in so aggressively, raising real interest rates, was reserved for emerging markets where people did not believe that fiscal expansions were credible or financed adequately. And as a real extension of that scenario, and some of your listeners might say, well, look, why are we even talking about this? It is because of that parallel, to what I’ve just said, is the experience of Brazil.

If you look at Brazil right now, they’re running a huge, huge fiscal deficit. But the primary deficit, with some possible manipulation, we’ll have to say, which happens all over the world, the primary deficit, which is the new spending, is actually less than half a percent of GDP. It’s compliant with their fiscal rule. The entire rest of the 8% and 9% fiscal deficit, which is in there, comes from really high interest rates.

And those really high interest rates come because the Brazilian central bank has made a mistake by cutting interest rates too quickly, allowed inflation to rise, and then had to allow markets to price in even higher interest rates, which they cannot get away from until inflation is under control. And I’m not saying that we’re all going to reach 14% and 15% policy rates.

But for the advanced economies with 100%, and 120%, and 140%, debt to GDP ratios, raising interest rates by 2 or 3 percentage points makes a huge difference in what the outcome’s going to be. That’s the unanchoring of central banking really that we are worried about.

[00:53:51] Kevin

Isn’t there some type of self-correcting mechanism that would happen in a highly indebted economy? I mean, I heard people say that, given how much debt there is, how levered financial balance sheets are, financial institution balance sheets, that if you get government bond yields above say 5% consistently, you’re going to trigger a funding crisis, essentially a recession, a credit crunch.

And so, interest rates, there may be pressure for them to go up, but it’s going to trigger a response, if you will, a forced deleveraging in a deflationary episode in the economy that will then bring interest rates back down. Do you put any stock in arguments like that or is that oversimplified?

[00:54:49] Manoj

No, I think they have some validity. I mean you’re seeing some of that happening here in the UK where, when the Labor administration came in the OBR, the Office for Budget Responsibility, had told them that the fiscal headroom that the government has is about £7 billion. Since then that fiscal headroom has increased to £22 billion. But, at the same time, it was a high spending, high revenue generation, hopeful budget that came out.

And we’re seeing that to the extent where that budget has not been able to generate growth, the market’s willingness to believe that that budget has been financed adequately by growth and by fiscal revenues has been really short lived. So, I think there are limits to how much markets will believe that this is essentially true.

And the second issue is that I think it’s not just individuals and markets who can lead to a decline in interest rates by having high borrowing costs, the government can react too. So, the government may make it very difficult to say that those high interest rates are going to have an impact on their spending by instituting financial repression or by forcing central banks to not be able to withstand political pressure and reduce interest rates, thereby reducing their interest expenses.

So, I think it’s very difficult until you have a crisis, either a small one or a big one, to really change the government’s perspective on what it needs to do. And the two sides of the story that they need to address are both really obvious and both incredibly difficult, to your point on implementation.

Number one, we all know that the non-discretionary part of budgets, which is predominantly health care, has to be somehow reduced. But until you find a way to please the population or an efficient AI robotics led version of health care, it’s very hard to do.

Second is you have to avoid the temptation to spend more money when it’s getting closer to election time. Good luck with that. These things are going to be… If the central bank can’t deliver lower interest rates one way or the other, making it harder for you to get reelected, you’re going to fall back on that crutch.

I think there is some merit to the points you raised, but equally, it’s unrealistic to think that this will happen in a smooth way without a real shock to governments.

[00:57:13] Kevin

So essentially, you’re imagining that we’ll kind of, I guess, bumble along a little bit in the way that we are now until there is a crisis. That the forces are almost like a structural change in how central banks relate to governments. Would you…

[00:57:36] Manoj

I think that’s absolutely right. There are some exceptions. So for example, we made a point of mentioning South Africa where there is actually monetary dominance in a highly indebted society. One of the latest things in a government, we have to note, which is it has been very cognizant of reducing its debt footprint.

The South African Reserve Bank, by choosing a lower inflation target de facto, has cut out 1.5% of nominal growth from fiscal projections, thereby forcing the government to be far more austere. And in New Zealand, another example that we made, the administration there is very focused on raising a primary surplus because it is aware of the challenges coming forward. These things can happen and they do happen, but they are more the exception than the rule.

[00:58:28] Kevin

Okay, well, I think that’s a good place for us to wrap up. Obviously, there’s a lot more in this book and I really encourage those of you who, if you thought these topics were interesting, and you like to really get to know them in a lot more detail, that you should pick up the book and go through it. It’s full of great graphs, really nice summaries at the beginning of each chapter. It’s very easy to choose the level of detail you want to go into.

So, I really appreciated it. And Manoj, I just want to thank you for writing the book and for being so generous with your time to come onto the show and explain some of the ideas to us.

[00:59:14] Manoj

Kevin, it’s been a pleasure. Honestly, I enjoyed the way the flow of the conversation took place. Like I said, there are very few people who are really bottom-up guys building up the foundations of demography before getting into the topics. I really like that. I enjoyed this very much. Thanks for having me.

[00:59:34] Kevin

Excellent. Okay, good. Well, the book is called The Unanchored Central Banker. Please make sure to get a copy and to follow Manoj’s work because I think you can tell from today’s conversation that many of these topics are not being discussed yet on mainstream media. But if history is any guide, they will be soon. So, get ahead of the curve.

For all of us here at Top Traders Unplugged, thanks for listening and we’ll see you next time.

[01:00:02] Ending

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