4:00

I hear people talking about whether he's

4:02

doing enough on climate change. Young

4:04

voters care so much more about inflation than they

4:06

do about climate change. I'm

4:10

Noam Hasenfeld, and this is the

4:12

second episode of Unexplainable's series on

4:14

economic mysteries. This week,

4:16

with inflation still at the top of so

4:19

many people's minds, how much

4:21

can we actually control it? Or

4:23

as one economist I spoke to put it,

4:25

What the heck just happened? And

4:28

what could we possibly do to make sure it

4:30

doesn't happen again? I'm

4:34

here to talk about the economy. What? Like

4:36

it's hard? You may be wondering, who got

4:38

all this money? Nobody knows. The money's not

4:40

here. Well, your

4:43

money's in Joe's house, on Mrs. Meiklin's house,

4:45

and a hundred others. It's just money. It's

4:47

made up. It doesn't exist. It's not real.

4:50

It's not alive. If you

4:52

believe it. Okay,

4:54

it's not like we don't know anything about

4:56

inflation. I mean, I kind

4:58

of knew nothing about inflation coming into

5:00

this. But over the last

5:02

few weeks, I've been talking to economists and

5:05

reporters, and they told me

5:07

that the best way to start understanding

5:09

how inflation works is to break the

5:11

theories down into two basic buckets. The

5:18

first bucket says that inflation comes from people

5:20

having too much money to spend. Maybe

5:23

they got lots of stimulus checks. Maybe

5:25

the government printed a whole bunch of cash. Or

5:28

maybe there's just a lot of people working

5:30

and getting paid. All that

5:32

money leads to more demand for stuff. People

5:35

buying more stuff, which drives up prices.

5:38

Or to put it all simply, too

5:40

much money, not enough stuff. So you

5:42

get inflation. You can think of

5:44

this bucket like a kind of seesaw. On

5:47

one side, you got inflation. We'll

5:49

use a synth sound for that. And

5:52

on the other side, unemployment. That's

5:54

going to be a piano. So if

5:57

unemployment goes down, more people will

5:59

be paid. are working, more money

6:01

to spend, inflation goes up.

6:04

On the flip side, if unemployment goes up,

6:08

there's fewer people working, less money to

6:10

spend, inflation comes

6:12

down, which is exactly what a

6:14

lot of major economists were pushing for when inflation

6:16

was skyrocketing a couple of years ago. Larry

6:19

Summers said things like this, that

6:21

you would need to see unemployment

6:23

rise significantly before you saw inflation

6:25

come down. There's

6:28

going to need to be increases in

6:30

unemployment to contain inflation.

6:35

It might seem kind of weird

6:37

to hear economists pushing for more

6:39

unemployment. They're advocating for

6:41

a worse economy. But

6:44

under this theory, it's just a zero-sum

6:46

game. The only way to

6:48

get inflation down is to get unemployment up.

6:51

It's a necessary pain. So

6:54

then how do you actually drive unemployment

6:56

up? The

6:58

idea is that the Fed, the central bank

7:00

that sets economic policy in the US, it

7:03

can raise interest rates, which makes it

7:05

harder for businesses to take out loans and

7:08

hire more people, which leads

7:10

to more unemployment. But

7:13

when the Fed did exactly that in 2022, the

7:16

Federal Reserve raised interest rates today

7:19

in its effort to stamp down

7:21

surging inflation. Something unexpected happened. Unemployment

7:24

didn't change at all. More

7:26

than half a million jobs were added

7:29

last month alone. But inflation

7:31

somehow went down. Inflation

7:33

is coming down hard, and it is coming

7:36

down a lot faster than I think people

7:38

thought. The two sides

7:40

of that inflation-unemployment seesaw, they

7:43

were both low. The theory

7:45

turns out to be badly wrong. It

7:48

turns out that you could have

7:50

falling inflation without rising unemployment. unemployment

8:00

at the same time. This

8:03

is where we get to the second stranger bucket

8:05

that I really want to focus on, which

8:07

is how most economists explain the way inflation

8:09

came down in 2022. It's

8:16

more complicated than just this simple

8:19

seesaw of unemployment going up and

8:21

inflation coming down. It's

8:23

how people feel about the economy

8:26

and what they think is going to happen in

8:28

the future. If you look at

8:30

most theories of inflation now, one

8:32

of the variables that you will see trying

8:35

to predict inflation is what

8:37

people expect inflation to be. Expectations.

8:41

Inflation somehow happens because people

8:43

expect it to happen. And

8:45

it goes away because people expect it to

8:47

go away. And that might seem a little

8:50

bit circular, but there's something

8:52

subtle and important happening there. When

8:54

you expect more inflation, you do

8:56

things that cause inflation. So

8:59

as a worker, you might demand a raise because

9:01

your prices are going to go up. And unless

9:03

you get a raise, your standard of living is

9:05

going to go down. So this

9:07

has a lot of the same mechanics as the

9:09

first bucket. People buying more stuff still leads to

9:11

inflation. But it's not

9:14

as simple as unemployment up inflation

9:16

down. It's more long term.

9:18

When businesses expect future prices to go

9:20

up across the board, they're going to

9:22

raise their own prices to keep up.

9:25

And if enough people and businesses are making

9:27

those kinds of decisions based on their expectations

9:29

of where the economy is going, it

9:31

becomes a self-fulfilling prophecy. This

9:35

whole idea of expectations came out of what

9:37

happened in the 70s and 80s, which is

9:40

the last time inflation was higher than it

9:42

was a couple of years ago. This is

9:44

a new strain of inflation, and it infects

9:46

the whole world. At that

9:48

point, after years of inflation, the

9:50

Fed eventually decided to follow the

9:53

seesaw model, jacking up interest rates,

9:55

triggering unemployment, just like they planned.

10:00

But inflation still stayed super

10:02

high. Economists weren't really

10:04

sure what to make of it. Why

10:07

wasn't the seesaw working? We

10:09

may have to change our minds about it

10:12

and simply accept high inflation and unemployment as

10:14

normal in a new world. So

10:16

they landed on a new idea. People

10:19

just didn't trust the Fed.

10:21

The past experiences any guide? The

10:24

future of our country is

10:26

in jeopardy. Inflation had

10:29

gone on for so long that regular

10:31

people didn't think the Fed's higher interest

10:33

rates would actually do anything. People came

10:35

to believe that the people who were

10:37

supposed to be the adults in the

10:39

room, the Fed, they were

10:41

just letting it happen and they didn't have the

10:44

stones to get it under control. Basically

10:46

the Fed lost credibility. We've

10:48

tried care and hope and this inflation

10:50

will not be charmed. So

10:53

the Fed needed to get that credibility back.

10:56

And it proved to people that these new interest

10:58

rates had teeth in staying power.

11:00

One cure is a great depression. So

11:03

they allowed interest rates to go sky

11:05

high, just pummeling the U.S. economy. High

11:07

interest rates and the restrictive money supply

11:09

are taking their toll with a consumer.

11:11

And it worked. Inflation

11:13

fell precipitously. The Fed

11:16

regained credibility and people began to see it

11:18

as an agency that took inflation seriously. I

11:20

think we owe you, Chairman Volcker, a rousing

11:22

vote of thanks for your great job in

11:24

bringing inflation down. Essentially

11:26

the Fed anchored people's

11:29

expectations. They convinced people

11:31

that no matter what, they wouldn't

11:33

let inflation spiral out of control.

11:37

And this is exactly how a lot of economists

11:40

explain what happened to us over the last couple

11:42

years. When the Fed raised

11:44

interest rates in 2022, they

11:46

basically reminded everyone there was an adult

11:48

in the room. That no matter what,

11:50

the Fed, essentially these people behind the

11:52

curtain of the economy, they'd

11:54

never let inflation get that bad again. But

11:58

this whole idea takes us to a... a pretty

12:01

strange place. Because

12:03

in a sense, it's not the exact

12:05

policy the Fed set, it's

12:07

that they got people to trust them, which

12:10

is weird. It can sound

12:13

a bit like voodoo and it is like

12:15

voodoo. Okay. But it does make the role

12:17

of the Fed almost

12:19

more psychological. That it's not

12:21

even about the actual policies they're doing so

12:23

much as, can they actually

12:26

reassure markets that things aren't going

12:28

to get out of control? When

12:30

Dylan told me this, I found it kind of

12:32

hard to believe. So I called

12:34

up Adam Pozen, who used to be a central banker

12:36

in New York and in the UK, you

12:39

know, one of those people behind the curtain of the

12:41

economy. And he told

12:43

me he actually had conversations about the

12:45

psychological aspect of interest rates all the

12:48

time. When I was on the policy

12:50

committee of the Bank of England, I

12:52

would go off to vote on policy and

12:54

my wife would kindly say, go make good

12:56

policy, as I went out the door. And

12:59

at one point she said, well, this

13:01

is just all a communications message. So

13:03

if you communicate to people that

13:06

you believe something and they believe you, then

13:08

it happens. So Adam would go to work

13:10

trying to get people to feel confident about

13:12

the economy. Essentially, yeah, that's a lot of

13:15

what it is. If you

13:17

convince people that you're willing

13:20

to take the steps necessary to

13:23

bring inflation down, meaning you're willing to raise

13:25

rates a lot and you're willing, if necessary,

13:27

to suffer unemployment or slower growth, then

13:30

people may believe you're willing to do it

13:32

and you don't actually have to go through

13:34

the process. According to this

13:36

theory, the Fed isn't just controlling

13:39

interest rates. They're shaping

13:41

people's beliefs about the world, which they

13:43

do by constantly being at the ready

13:45

to adjust those interest rates. But

13:48

no one really knows just how ready they

13:50

have to be. We don't

13:53

know how long it takes

13:55

people to change their mind

13:57

about inflation, how

13:59

much the... path of past inflation

14:01

affects their thinking about future inflation.

14:03

We don't know how high interest

14:05

rates have to go in order

14:07

to anchor people's expectations. We

14:10

don't know how long these expectations last. There's

14:12

a lot of things we don't know. So

14:14

for central bankers like Adam, the

14:17

psychological part of this creates a

14:19

kind of funny tension. You

14:21

don't want to give people false

14:24

impressions that you

14:26

know precisely what's going to happen.

14:29

But you don't want to communicate to people

14:31

how uncertain you are. Adam had to

14:33

deal with this kind of thing during the financial crisis in 2009,

14:36

when he was pushing for banks in the UK

14:38

to buy up all these government bonds. It was

14:40

all speculative. None of us knew exactly what was

14:43

the right amount, how long it would take, or

14:46

even the mechanisms necessarily. But in order

14:48

for the plan to work, Adam didn't

14:50

want to be honest about all that

14:52

uncertainty. We decided that none of us

14:54

would go out in public and start

14:56

saying, well, I'm not sure this is

14:58

going to work. Oh, I know I'm

15:00

really uncertain about this part because then

15:03

it was even less likely to

15:05

work. So it's showing confidence to

15:07

instill confidence. If

15:12

I'm being honest, this is not exactly

15:14

what I pictured the Fed doing behind

15:16

the curtain. I thought the

15:18

Fed was almost like this kind of

15:20

supercomputer, figuring out the precise mathematical way

15:22

to balance the economy just right. But

15:26

the Fed's most important role might just

15:28

be when that curtain opens, performing

15:30

a kind of theater. It's

15:33

less about exactly what they do than it

15:35

is about how they do it, publicly

15:37

and confidently. Like

15:40

Adam said, it's showing confidence to

15:42

instill confidence. Now,

15:44

to be clear, it's not just theater.

15:46

The Fed raising interest rates does make

15:48

it harder for people to make big

15:50

purchases. It makes it harder for businesses

15:52

to expand. But according

15:55

to Adam, the bigger, more enduring

15:57

impact of raising interest rates might

15:59

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Com. This

28:05

was the second episode Unexplainable is doing

28:07

on economic mysteries. Next

28:10

week, how understanding our economy

28:12

might just come down to

28:14

understanding chaos. I've been

28:16

educated as a physicist, and I was

28:18

used to motions that were regular. So

28:21

having the realization that the

28:24

world could be unpredictable was

28:26

kind of mind-blowing. This

28:30

episode was produced by me, Noam Hasenfeld.

28:32

We had edits from Marianne McKeown with help

28:35

from Jorge Justin Meredith-Hodna, who runs our team.

28:38

Mixing and sound design from Christian Ayala,

28:40

music from me, fact-checking from Melissa Hirsch,

28:43

and all kinds of help from Mendingwen. Bird

28:46

Pinkerton watched as more and more platypuses

28:48

started emerging out of the tree roots.

28:51

Slowly, one platypus walked over

28:53

to Bird, paused,

28:56

and nodded. The platypuses

28:58

were ready to join the war. Special

29:03

thanks to Emily Stewart and Dylan Matthews for their

29:05

help with this episode. And thanks as

29:07

always to Brian Resnick for co-founding the show. If

29:10

you have questions or thoughts about this episode,

29:12

you can email us at Unexplainable at vox.com.

29:15

You can also support the show and all

29:17

of Vox's journalism by joining our membership program

29:19

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29:23

if you really love supporting us, leave us a

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nice rating or review wherever you listen. It

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really helps us out a lot. Unexplainable

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is part of the Vox Media Podcast Network,

29:33

and we'll be back next week.