Episode summary
Why the Effect of War Might Hit the Economy Sooner Than We Think
Wall Street Week
· · 10 min · Hosts: Chrystia Freeland, David Westin · Guests: Randal Quarles
Summary
Randal Quarles argues that the war-driven uncertainty now hanging over the economy is likely to keep the Federal Reserve on hold, because the main forces he sees are more inflationary than disinflationary. He says the Fed’s job is always to make policy under uncertainty, but that the current level is unusually high and leaves little case for either higher or lower rates in the near term. In his view, the balance of risks points to no change in the Fed’s policy stance for the rest of the year.
He says uncertainty should show up quickly in weaker business investment, because firms delay capital spending when they cannot judge the environment they are investing into. He also expects higher energy prices to hit consumer spending and broader demand if the shock lasts long enough, though a brief disruption would be only a blip from the Fed’s perspective. Quarles adds that tariffs are probably a temporary inflation impulse, but the way they were rolled out could make the inflation effect linger a bit longer.
On labor, Quarles says immigration policy has materially reduced labor supply, offsetting some of the softness in jobs data. He thinks the Fed may be overestimating labor-market weakness, and says that supports a policy bias that remains on the higher side of expectations rather than toward rate cuts.
Key takeaways
- Quarles says war-related uncertainty is high enough that the Fed should likely hold rates steady for some time.
- He expects business investment to weaken quickly because firms do not know what environment they are investing into.
- Quarles says higher energy prices can feed into consumer spending cuts and broader demand destruction if the shock lasts more than a month or two.
- He argues tariffs are still inflationary, but the biggest risk is a slightly longer inflation pulse because of how policy has been rolled out.
- Quarles says immigration policy has reduced labor supply by roughly one to two million people a year, offsetting labor-demand softness.
Notable quotes
“I think, however, when you're at a level of uncertainty like this, you have to look at what you think the fundamental drivers of the economy are likely to be”
“those drivers currently are more inflationary than non-inflationary and will therefore probably argue for probably no change in the Federal Reserve's monetary policy stance”
“you start seeing that relatively quickly in terms of lowered business investment, because you don't know exactly what environment you're investing into”
“I think the balance over the course of the next several months is likely to be in favor of no moves, either down or up”
“I think you can expect... the Fed can kind of expect to look through tariff policy”
How the episode opens
We heard from the Federal Reserve and from Chair Powell this week, and maybe the headline is the uncertainty because of the war in Iran. He was very careful in saying "We don't know what the effects will be, big, small or in between. How does one make policy in the face of that kind of uncertainty?
-Well, you know, writ large, that's the job of the Fed generally. The Fed is always in a position of uncertainty. That uncertainty may be greater from moment to moment.
It's obviously at a fairly high level now. But that's really what's behind the Fed's regular mantra of we'll be data dependent. It's the data could be different next meeting than they are today.
On the basis of what we know now, this is where we would be likely to go. I think, however, when you're at a level of uncertainty like this, you have to look at what you think the fundamental drivers of the economy are likely to be, as you think going forward. And I think that those drivers currently are more inflationary than non-inflationary and will therefore probably argue for probably no change in the Federal Reserve's monetary policy stance for some time into the future.
I don't think that where the economy is going is going to argue for raising interest rates. But I think the argument for lowering interest rates is going to be hard to carry probably for the rest of this year. Westin: On the uncertainty, just for one more moment on that.
At what point does the uncertainty itself start to weigh on the economy? Because businesses might be reluctant to make investments. Consumers may hold off on spending.
How long can we go before we start to see, you think, in the economy?
From the episode’s captions: roughly the first two minutes, lightly cleaned. Keep watching on YouTube →
Topics
- war uncertainty
- business investment
- economic outlook
- volatility
- risk assessment
Watch the episode
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Summary, takeaways and quote selection by Octagon. Quotes are short excerpts; the full conversation is in the episode.
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