WEBVTT - How An Old Banking Regulation May Have Driven The 1970s Inflation 0:00:10.640 --> 0:00:14.680 Hello, and welcome to another episode of the Odd Lots podcast. 0:00:14.760 --> 0:00:17.000 I'm Joe Wisenthal and I'm Tracy Alloway. 0:00:18.079 --> 0:00:22.279 Tracy, you know obviously recording this September twenty twenty three. 0:00:22.320 --> 0:00:25.840 Inflation has come way down over the last year, but 0:00:25.920 --> 0:00:28.920 there is definitely anxiety about, well, could we see another wave, 0:00:29.120 --> 0:00:31.760 particularly if we don't have a recession, Like, no one 0:00:31.840 --> 0:00:34.519 is really convinced that it's over. 0:00:34.560 --> 0:00:37.600 Right, So gas prices are starting to creep up again. 0:00:38.159 --> 0:00:41.640 House prices have been incredibly stable and also starting to 0:00:41.760 --> 0:00:45.080 rise slightly, so that could also figure into shelter costs. 0:00:45.159 --> 0:00:48.440 But I think generally there is this concern that are 0:00:48.479 --> 0:00:51.559 we going to see another leg up in inflation? And 0:00:51.640 --> 0:00:53.720 part of the reason there seems to be this concern 0:00:53.960 --> 0:00:57.440 is because, as we've discussed on this podcast before, everyone 0:00:57.560 --> 0:01:00.680 tends to reach for the nineteen seventies as the big 0:01:00.800 --> 0:01:04.960 parallel or analogy for periods of higher inflation. 0:01:05.600 --> 0:01:08.440 Right, you know, when we were out in Jackson Hole, 0:01:08.720 --> 0:01:12.600 I guess in August that was when Larry Summers tweeted 0:01:12.600 --> 0:01:15.440 that famous chart saying, you know it was a good reminder, 0:01:15.520 --> 0:01:16.959 right that this was when you. 0:01:16.920 --> 0:01:19.840 Were looking at the mountains and thinking of USCPI charge. 0:01:19.920 --> 0:01:23.399 Yeah, the Grand Teetons looked like the USCPI from nineteen 0:01:23.480 --> 0:01:26.360 seventy four to nineteen eighty five. But it's true that 0:01:26.600 --> 0:01:30.240 throughout the seventies there were multiple times where people sort 0:01:30.280 --> 0:01:32.880 of breathed a sigh of relief, they said, inflation has 0:01:32.920 --> 0:01:35.480 been licked, and then it came back. And it's really 0:01:35.520 --> 0:01:37.880 you know, there's this story that there's all this respon 0:01:38.000 --> 0:01:42.000 irresponsible policy and then finally Vulgar came and smashed inflation, 0:01:42.280 --> 0:01:44.399 and it really did not exactly happen like. 0:01:44.360 --> 0:01:44.800 That, right. 0:01:44.840 --> 0:01:47.360 I always find that kind of weird because Arthur Burns 0:01:47.440 --> 0:01:51.440 hiked RAITs a lot before Vulker did the same thing. 0:01:51.800 --> 0:01:55.400 But you're absolutely right, and the inflation of the nineteen 0:01:55.480 --> 0:02:00.480 seventies it's important in many ways, possibly not the right ones, 0:02:00.520 --> 0:02:02.760 but one of the ways that's important is it tends 0:02:02.840 --> 0:02:05.560 to be the period that a lot of our policy 0:02:05.600 --> 0:02:09.760 makers and economists and academics kind of came of age in, 0:02:10.200 --> 0:02:12.400 and it tends to be the one that they go 0:02:12.600 --> 0:02:16.720 back to to explain what's happening now. And so, you know, 0:02:17.120 --> 0:02:20.120 there are some shades of the nineteen seventies to our 0:02:20.160 --> 0:02:23.560 current situation. You did have supply shocks in the form 0:02:23.680 --> 0:02:26.639 of oil. There was I think some fiscal stimulus from 0:02:26.639 --> 0:02:29.560 the Vietnam War going into the nineteen seventies, things like that. 0:02:30.120 --> 0:02:33.919 But overall, the sort of standard interpretation of the nineteen 0:02:33.919 --> 0:02:38.079 seventies is that monetarist view the old like Milton Friedman, 0:02:38.520 --> 0:02:42.400 inflation is always in everywhere a monetary phenomenon and basically 0:02:42.400 --> 0:02:45.320 blaming the FED for not reacting fast enough. 0:02:45.400 --> 0:02:49.200 You're absolutely right, and you mentioned that the nineteen seventies 0:02:49.840 --> 0:02:53.440 looms so large. You know, policy makers the FED, in 0:02:53.520 --> 0:02:57.640 particular central bankers, they take a lot of pride in 0:02:57.720 --> 0:03:01.400 the fact that they defeated inflation, that inflation has been stable, 0:03:01.440 --> 0:03:03.680 that they sort of embedded this idea of stable and 0:03:03.720 --> 0:03:08.320 inflation expectations. They prize that stability quite a bit. You 0:03:08.400 --> 0:03:10.200 and I we joke a lot about how we both 0:03:10.240 --> 0:03:12.160 started our careers in two thousand and eight right on 0:03:12.200 --> 0:03:14.040 the eve of the crisis. 0:03:13.360 --> 0:03:14.799 And we're always worried about defuse. 0:03:14.800 --> 0:03:17.240 We're always worried about, you know, crisis and downturn and 0:03:17.240 --> 0:03:19.720 surging unemployment. So it had, you know, and you look 0:03:19.720 --> 0:03:22.840 at the people who now make policy today, many of them, 0:03:22.880 --> 0:03:25.640 as you said, came of age then. But again, it 0:03:25.720 --> 0:03:28.200 feels as though if we're going to have a conversation 0:03:28.320 --> 0:03:31.640 about possible second waves, if we're going to compare and 0:03:31.720 --> 0:03:35.400 contrast now with the nineteen seventies, then actually we better 0:03:35.440 --> 0:03:37.720 get a better handle on what really happened in the 0:03:37.760 --> 0:03:40.920 nineteen seventies, because I don't think that outside of these 0:03:41.000 --> 0:03:43.400 vague things like oh, they let policy run too loose 0:03:43.480 --> 0:03:47.360 and some oil and gas lines, that actually we've really 0:03:47.920 --> 0:03:51.080 you know, that there is a crisp, coherent story like yeah, 0:03:51.080 --> 0:03:55.160 but why was inflation so persistent and so reoccurring throughout, 0:03:55.200 --> 0:03:56.320 you know, roughly a decade. 0:03:56.560 --> 0:03:58.440 The ghost of Paul Volker is going to be so 0:03:58.520 --> 0:04:00.000 mad at us, But I think we should do that. 0:04:00.600 --> 0:04:00.760 Well. 0:04:00.800 --> 0:04:03.520 I am very excited. We have the perfect guest, someone 0:04:03.520 --> 0:04:08.280 who has done original research on nineteen seventies inflation and 0:04:08.360 --> 0:04:10.880 really sort of broke down what happened. We're going to 0:04:10.960 --> 0:04:14.000 be speaking with Itamar Drexler. He is a professor of 0:04:14.080 --> 0:04:17.080 finance at the University of Pennsylvania, someone who's done a 0:04:17.120 --> 0:04:19.239 lot of research on this period and what it means. 0:04:19.240 --> 0:04:21.920 Professor Drexler, thank you so much for coming on odd Laws. 0:04:22.080 --> 0:04:24.520 Thank you very much for having me. This is really 0:04:24.520 --> 0:04:27.520 fun and nice to talk about a topic I care 0:04:27.520 --> 0:04:28.840 a lot about and think is very interesting. 0:04:28.920 --> 0:04:31.720 Excellent. Well, you know what, why don't we start with 0:04:32.080 --> 0:04:34.760 if you were just in a room full of random 0:04:34.800 --> 0:04:39.200 economists and you said, well, what caused the nineteen seventies inflation? 0:04:39.279 --> 0:04:41.600 Why did it keep coming back? What sort of just 0:04:41.640 --> 0:04:44.120 like you know, we mentioned in the beginning, you know, 0:04:44.160 --> 0:04:46.840 the the gas lines and the end of the Vietnam War, 0:04:46.880 --> 0:04:51.200 and maybe policymakers were not strong enough in fighting it. 0:04:51.240 --> 0:04:55.080 But what is the sort of macro consensus about what 0:04:55.240 --> 0:04:56.320 happened in that decade? 0:04:57.160 --> 0:05:00.920 So I think the most common story narrati is that 0:05:01.320 --> 0:05:04.400 the Fed there were at the outset, say, some kind 0:05:04.440 --> 0:05:07.040 of shocks that led to the beginning of inflation, but 0:05:07.080 --> 0:05:10.960 that once inflation got going, the FED did not respond 0:05:11.040 --> 0:05:15.280 aggressively enough to increases in inflation by raising the FED 0:05:15.320 --> 0:05:19.080 funds rate as later policy would dictate, which is that, 0:05:19.200 --> 0:05:21.479 according to the tailor rule, the FED has to raise 0:05:21.720 --> 0:05:24.960 the nominal rate more than one for one with expected inflation. 0:05:25.560 --> 0:05:28.360 What that does is raise the real interest rate. They're 0:05:28.400 --> 0:05:31.640 by lowering demand or what they call demand management, and 0:05:31.800 --> 0:05:35.480 preventing inflation. From accommodating inflation by letting it go up, 0:05:35.520 --> 0:05:40.400 and so not doing that, they overtime lost credibility, and 0:05:40.440 --> 0:05:43.640 that meant that if people expected inflation to go up, 0:05:43.880 --> 0:05:46.840 inflation would actually go up because the FED wasn't actually 0:05:46.920 --> 0:05:49.960 leaning into it. It wasn't making it wasn't slowing demand 0:05:50.040 --> 0:05:53.640 in the face of say, increasing inflation expectations. That, to 0:05:54.000 --> 0:05:56.680 the best that I understand, is kind of the most 0:05:56.680 --> 0:05:57.600 common narrative. 0:05:57.920 --> 0:06:01.880 Right, So the ideas the prices started to rise, the 0:06:01.880 --> 0:06:05.039 FED basically lost control of inflation expectations, and then you 0:06:05.120 --> 0:06:09.160 got this self reinforcing cycle of the wage price spiral 0:06:09.200 --> 0:06:12.360 where people start demanding more money. And then it wasn't 0:06:12.440 --> 0:06:16.520 until Paul Volker came in told everyone whose boss re 0:06:16.800 --> 0:06:21.320 established the Fed's credibility and kind of deflated those inflation 0:06:21.520 --> 0:06:26.960 expectations that things got better. Right, Yeah, So your paper 0:06:27.520 --> 0:06:31.760 takes a very different view to that whole narrative. You 0:06:31.880 --> 0:06:36.240 kind of placed the blames squarely on an element of 0:06:36.360 --> 0:06:39.640 financial regulation that actually Joe I realized this has popped 0:06:39.720 --> 0:06:42.560 up a couple times on all thoughts, most notably in 0:06:42.600 --> 0:06:45.200 our episodes with Josh Younger and Lev Menon where we 0:06:45.200 --> 0:06:48.120 were talking about the origins of your dollars in shadow banks, 0:06:48.640 --> 0:06:52.320 but you place it on REGQ. Can you talk a 0:06:52.360 --> 0:06:53.679 little bit more about that thesis. 0:06:54.160 --> 0:06:56.680 Yeah, sure, So reg Q does come up a lot. 0:06:56.720 --> 0:07:01.360 It's a very famous banking regulation. Historically, people, many banking 0:07:01.400 --> 0:07:04.400 people and monetary people are well aware of it. So 0:07:04.680 --> 0:07:07.200 red Q was a regulation that came out of the 0:07:07.320 --> 0:07:11.280 nineteen thirty three Banking Act that allowed the Fed to 0:07:11.320 --> 0:07:14.240 place a ceiling on what banks could pay, what kind 0:07:14.280 --> 0:07:16.960 of interest rates banks could pay on different kinds of deposits, 0:07:17.440 --> 0:07:20.160 and for example, checking deposits had to pay a zero 0:07:20.200 --> 0:07:23.080 interest rate. Savings deposits had their own ceiling, and then 0:07:23.160 --> 0:07:27.160 CDs could have their own ceiling. For almost all of 0:07:27.160 --> 0:07:30.200 the time from nineteen thirty three until nineteen sixty five, 0:07:30.600 --> 0:07:33.280 the FED put the ceiling above the Fed Funds rate, 0:07:33.360 --> 0:07:34.920 so when it would raise the Fed Funds rate, it 0:07:34.960 --> 0:07:37.800 would raise the ceiling, and so basically it didn't bind. 0:07:37.880 --> 0:07:40.800 Maybe it would prevent you from setting some crazy rate, 0:07:40.880 --> 0:07:43.960 but it didn't bind. But starting in sixty five, they 0:07:44.520 --> 0:07:46.600 didn't raise it, so that when they would raise the 0:07:46.640 --> 0:07:48.960 Fed Funds rate, deposits couldn't keep up with the Fed 0:07:48.960 --> 0:07:49.400 Funds rate. 0:07:49.520 --> 0:07:53.480 So the reason they put in that restriction was because 0:07:53.600 --> 0:07:56.240 my understanding is that in the nineteen thirties there was 0:07:56.640 --> 0:07:58.480 there were a lot of bank failures, and so there 0:07:58.520 --> 0:08:01.880 was concern that if banks were competing with each other 0:08:02.000 --> 0:08:07.400 to attract depositors, so just raising deposit rates to uneconomic levels, 0:08:07.600 --> 0:08:10.400 that it would lead to more bank failure. So they thought, well, 0:08:10.400 --> 0:08:13.000 we'll put a cap on this and then we'll have 0:08:13.200 --> 0:08:14.240 healthier competition. 0:08:14.360 --> 0:08:16.800 Is that right, that's the story that's told. I know 0:08:16.920 --> 0:08:19.240 it's impossible to say that's exactly what was in their mind, 0:08:19.280 --> 0:08:21.960 but yes, also that act established they have d IC 0:08:22.080 --> 0:08:24.520 and deposit insurance, So in some sense it makes it 0:08:24.560 --> 0:08:26.840 makes sense if you're going to give people insurance, you 0:08:26.840 --> 0:08:30.160 don't want them to attract deposits by doing crazy things. 0:08:30.240 --> 0:08:33.760 Right because if you're if you know that you're insured. 0:08:34.280 --> 0:08:36.560 I could just go out and say, oh, here, here's 0:08:36.559 --> 0:08:37.160 ten percent. 0:08:37.720 --> 0:08:40.400 The Bank of Joe and Tracy will offer fifty percent. 0:08:40.200 --> 0:08:43.480 Interest cent I collect all of the deposits from everyone else, 0:08:43.520 --> 0:08:46.120 and maybe I fail because whatever I'm doing with that, 0:08:46.280 --> 0:08:48.959 but I got all the deposit I mean, let's do it. 0:08:49.200 --> 0:08:53.079 Yeah, okay, So I stopped you right up. In the 0:08:53.160 --> 0:08:55.800 late nineteen sixties. So in the late nineteen sixties they 0:08:55.880 --> 0:08:57.160 make this change. 0:08:57.520 --> 0:09:00.440 Yeah, they decide, they debate it, but they just to 0:09:00.559 --> 0:09:04.480 use this rule as a tool of monetary policy very consciously. 0:09:04.840 --> 0:09:08.040 So this is part of a general wave of what 0:09:08.200 --> 0:09:11.480 was called credit controls that many developed countries used and 0:09:11.559 --> 0:09:14.160 had been exploring for a while. It was a popular 0:09:14.200 --> 0:09:18.280 idea that you could influence directly the price and quantity 0:09:18.280 --> 0:09:21.960 of credit in order to do monetary policy and not 0:09:22.200 --> 0:09:25.040 just leave it to the short term rate. And so 0:09:25.120 --> 0:09:28.079 this was used in the UK famously, in France and 0:09:28.160 --> 0:09:31.319 Italy and Belgium. In the Netherlands, there was an awareness 0:09:31.360 --> 0:09:35.480 that credit controls of various types were used, usually consisting 0:09:35.520 --> 0:09:38.760 of often together controls on the level of interest rates 0:09:38.760 --> 0:09:41.680 you could pay on deposit, ceilings on what you could 0:09:41.760 --> 0:09:44.600 charge for loans, or ceilings on the quantity of loans 0:09:44.640 --> 0:09:45.880 you could make, or loan growth. 0:09:46.640 --> 0:09:49.600 You know, it's interesting because and I will get to 0:09:49.640 --> 0:09:52.440 the whole debunking of the popular story, or at least 0:09:52.440 --> 0:09:55.600 the reinterpretation of the popular story. Actually have two questions 0:09:55.640 --> 0:09:58.679 from a professional standpoint, how did this become an area 0:09:58.679 --> 0:10:00.120 of interest and research. 0:09:59.840 --> 0:10:02.840 For Yeah, so it's a little bit out of left 0:10:02.840 --> 0:10:05.040 field for me and my co authors. I have two 0:10:05.160 --> 0:10:07.640 very common co authors that we've worked a ton together 0:10:07.920 --> 0:10:11.079 at NYU, Alexisavov and Philip Novel, and we work on 0:10:11.440 --> 0:10:13.960 monetary policy and banking. We're coming at it from a 0:10:14.000 --> 0:10:16.120 finance point of view and the way we got to 0:10:16.160 --> 0:10:19.520 this so we think a lot about these things. We 0:10:19.559 --> 0:10:21.839 did not think so much about inflation. We're working on 0:10:21.920 --> 0:10:25.120 how the business of banking works and how bank's ability 0:10:25.160 --> 0:10:28.760 to raise deposits is influenced by monetary policy, how much 0:10:28.880 --> 0:10:31.880 money they make on deposits, spreads, And we're presenting some 0:10:31.960 --> 0:10:35.040 of our work and we noticed that if you just 0:10:35.200 --> 0:10:38.760 g the FED Funds rate against deposit rates, the average 0:10:38.800 --> 0:10:42.360 deposit rate that banks pay, you can see very clearly 0:10:42.559 --> 0:10:46.400 that in the nineteen sixties and seventies the average deposit 0:10:46.480 --> 0:10:50.160 rate barely reacted at all to the Fed Funds rate. Now, 0:10:50.160 --> 0:10:53.120 that's not a discovery, because I knew about regulation Q 0:10:53.360 --> 0:10:55.840 and just had never never been in my face that way. 0:10:56.240 --> 0:10:58.400 And there's a very famous graph coming out of the 0:10:58.440 --> 0:11:01.839 literature of the standard now narrative Clarida Galley Gertler is 0:11:01.880 --> 0:11:04.559 the most famous paper with thousands of citations. That is 0:11:04.600 --> 0:11:07.079 a similar graph, but instead of deposit rates, which they 0:11:07.160 --> 0:11:10.079 don't consider, they have the Fed funds are in inflation. And 0:11:10.080 --> 0:11:13.480 that's the famous graph that shows that before nineteen eighty two, 0:11:14.320 --> 0:11:17.240 the Fed funds rate just mostly kind of sticks to inflation, 0:11:17.320 --> 0:11:20.520 whereas afterwards, with Vulcar and green Span, it reacts more 0:11:20.559 --> 0:11:23.160 than one for one. And the idea was that sensitivity 0:11:23.200 --> 0:11:26.480 heightens the sensitivity and of policy in people's reaction to inflation. 0:11:26.760 --> 0:11:30.240 But here we saw that deposit rates are also kind 0:11:30.280 --> 0:11:32.280 of look like that. I thought the timing was sort 0:11:32.280 --> 0:11:35.280 of better. And if you think that the people's deposits 0:11:35.280 --> 0:11:37.080 is an important part of their savings, which it is 0:11:37.120 --> 0:11:41.360 an important aspect of transmission of monetary policy across our mind, 0:11:41.440 --> 0:11:44.240 that maybe another thing that could have gone in there 0:11:44.280 --> 0:11:46.640 is that deposit rates did not react at all, and 0:11:46.640 --> 0:11:48.640 we knew that reg Q was there, so we start 0:11:48.679 --> 0:11:50.400 to thinking maybe that has something to do with the 0:11:50.440 --> 0:11:53.439 macro of the time and inflation. You start to look, 0:11:53.480 --> 0:11:55.760 there's a lot of there's a lot of smoke and 0:11:55.800 --> 0:11:56.520 fire there. 0:12:12.000 --> 0:12:15.160 Before we get into the specific sort of discovery of 0:12:15.200 --> 0:12:17.880 your research. One thing that strikes me is interesting and 0:12:18.000 --> 0:12:20.520 Tracy mentioned this at the beginning, which is the sort 0:12:20.559 --> 0:12:23.240 of we think of vulgar as the start of this 0:12:23.360 --> 0:12:27.760 sort of monitorius turn in policy in which the entire 0:12:27.880 --> 0:12:30.400 goal or the thinking at the time was, well, we 0:12:30.440 --> 0:12:33.520 can solve the inflation problem, if we can solve the 0:12:33.520 --> 0:12:35.559 supply of money problem, if we can sort of get 0:12:35.559 --> 0:12:37.600 a handle on the supply of money problem, then inflation 0:12:37.640 --> 0:12:40.360 will take care of itself. Judging by what you're saying 0:12:40.400 --> 0:12:43.080 about credit controls and this, like, Okay, this is how 0:12:43.160 --> 0:12:45.000 much we want to have in checking, This is how 0:12:45.080 --> 0:12:47.319 much we want to have in people's savings accounts, this 0:12:47.360 --> 0:12:50.080 is the cap on CDs. It felt it sounds like 0:12:50.120 --> 0:12:52.320 this was brewing for a while, that it was very 0:12:52.360 --> 0:12:56.440 popular already for some time for policymakers to really think 0:12:56.480 --> 0:13:00.360 about like bucketing different types of money and keeping sort 0:13:00.400 --> 0:13:02.080 of lid or handle on each of. 0:13:02.080 --> 0:13:04.439 Them the way we hear things now. I also had 0:13:04.480 --> 0:13:06.800 the impression that there was a lot of monetarism at 0:13:06.840 --> 0:13:10.200 the time looking for it. It's after the fact not 0:13:10.360 --> 0:13:13.000 as much of my impression. Certainly, these ideas are out there, 0:13:13.000 --> 0:13:16.880 but I feel like the monitorism specifically comes somewhat later. Actually, 0:13:16.880 --> 0:13:18.840 if you read the way they talked about it, demand 0:13:19.000 --> 0:13:21.560 management often sounds not that different than we talk about 0:13:21.600 --> 0:13:23.520 it today. What I will say is, I usually say 0:13:23.520 --> 0:13:25.120 this at the end of the talk, is I think 0:13:25.240 --> 0:13:27.640 so there was a lot of there was it by 0:13:27.679 --> 0:13:29.600 the end, a lot of looking at growth and the 0:13:29.600 --> 0:13:33.240 money supply and in trying to keep tamping down growth 0:13:33.240 --> 0:13:35.160 in this and a big part of the money supply 0:13:35.240 --> 0:13:38.440 and the most responsive are deposits. So jumping sort of 0:13:38.440 --> 0:13:40.560 to something I usually say at the end, I think 0:13:40.679 --> 0:13:42.960 that I'm not a big fan of moneitorism, and I 0:13:42.960 --> 0:13:45.840 think most of the mainstream macro and monetari is not. 0:13:45.920 --> 0:13:48.959 Now doesn't mean it's wrong, but I think monitoris a 0:13:48.960 --> 0:13:51.880 little bit don't understand their own theory. So what I 0:13:51.920 --> 0:13:54.040 mean by this is if you want to reinterpret what 0:13:54.080 --> 0:13:56.600 happened in terms of moneitorism, so you start out with 0:13:56.720 --> 0:13:59.280 why do people hold money? This is like standard monitorism. 0:13:59.679 --> 0:14:03.400 Money is you know, pays no interest and so it's 0:14:03.400 --> 0:14:06.200 a dominated asset and must have some other use. And 0:14:06.280 --> 0:14:08.520 as you raise, as you lower the interest rate, you 0:14:08.559 --> 0:14:10.679 make it more you know, easy for people to have 0:14:10.720 --> 0:14:13.320 money and they can spend more. So the thing is 0:14:13.480 --> 0:14:17.119 it treats each each money as just number of dollars. 0:14:17.520 --> 0:14:18.959 But in the what you see in the right Q 0:14:19.120 --> 0:14:21.720 time is when you don't let deposits pay the interest 0:14:21.760 --> 0:14:25.080 that they want, each dollar is now missing a lot 0:14:25.120 --> 0:14:28.200 of interest. So in that sense, its opportunity cost is 0:14:28.240 --> 0:14:32.160 going way up. So people take out deposits. There's less dollars, 0:14:32.440 --> 0:14:36.080 but each dollar is much more money, much more dominated 0:14:36.560 --> 0:14:39.200 than it was before. So though you have less dollars, 0:14:39.240 --> 0:14:42.200 the cost to people holding those dollars is way bigger 0:14:42.480 --> 0:14:45.520 when the number of dollars is smaller, when this ceiling 0:14:45.560 --> 0:14:49.280 binds tightly. And so that actually suggests that if you 0:14:49.320 --> 0:14:51.240 sort of don't make this jump of thinking about the 0:14:51.360 --> 0:14:53.800 number of dollars, but the opportunity cost of holding dollars, 0:14:54.240 --> 0:14:57.400 the amount of money that's that's that's sort of burning 0:14:57.400 --> 0:14:59.800 a hole in people's pocket, is actually much higher when 0:15:00.160 --> 0:15:02.560 were high and the ceiling was binding, then when there 0:15:02.600 --> 0:15:04.960 was more dollars but the ceiling was not binding. 0:15:05.600 --> 0:15:07.640 The ghost of Milton Friedman is going to haunt us 0:15:07.640 --> 0:15:11.320 too on this podcast. Okay, well, take that line of thinking, 0:15:11.400 --> 0:15:13.880 or that pushback on the monetarist view and apply it 0:15:13.920 --> 0:15:18.880 to the binding REGQ ceiling and inflation in the nineteen seventies. 0:15:19.000 --> 0:15:22.640 So you know prices are going up, but banks are 0:15:22.680 --> 0:15:26.840 restricted from paying out more deposits to savers. How does 0:15:26.880 --> 0:15:27.960 that impact prices? 0:15:28.160 --> 0:15:31.560 The idea was that by not letting them pay the 0:15:31.600 --> 0:15:34.800 interest that they want, some deposits would leave the banks. 0:15:34.960 --> 0:15:37.600 That was the in fact intention, That is what happened. 0:15:37.600 --> 0:15:40.680 It was called disintermediation, and so deposits would flow out. 0:15:40.920 --> 0:15:43.880 The idea I believe was that this would tampen down 0:15:43.880 --> 0:15:47.560 demand because credit growth was the source of excess demand, 0:15:47.920 --> 0:15:50.200 and that would help, just like raising the interest rate 0:15:50.200 --> 0:15:53.000 should help. However, what we argue was it led to 0:15:53.040 --> 0:15:56.320 the disintermediation, but instead of having a stronger effect on 0:15:56.400 --> 0:15:59.040 demand or only an effect on demand, what it had 0:15:59.080 --> 0:16:02.480 a strong effect was on the supply by firms, by producers, 0:16:02.520 --> 0:16:05.720 because it's been well documented that each of the times 0:16:05.720 --> 0:16:08.880 that the Fed funds rate went above the ceiling rate, 0:16:08.920 --> 0:16:11.120 which happened a lot during this time periods, whenever they 0:16:11.200 --> 0:16:14.880 raised rates, then as deposits flowed out, there were credit crunches, 0:16:15.240 --> 0:16:18.720 meaning firms wanted credit. Banks wanted to raise more deposits, 0:16:18.880 --> 0:16:21.400 they couldn't pay the rate they couldn't get enough deposits, 0:16:21.400 --> 0:16:23.560 so they started to ration firms. And so if the 0:16:23.640 --> 0:16:27.680 credit became scarce and expensive, now firms need credit to 0:16:27.760 --> 0:16:30.120 do business. I think that's kind of clear. So it's 0:16:30.120 --> 0:16:32.120 an input. Think of it like oil, but a much 0:16:32.120 --> 0:16:34.880 more important input. If you can't get it, what do 0:16:34.920 --> 0:16:38.320 you do? You fall behind in producing things. You cut supply, 0:16:38.520 --> 0:16:41.360 and you raise prices because it's more expensive to produce. 0:16:41.600 --> 0:16:44.280 And so we show that each of these cycles where 0:16:44.880 --> 0:16:48.960 they raised rates where the ceiling was binding, you see both. Well, 0:16:49.000 --> 0:16:50.880 you see this is known. You see both inflation and 0:16:50.920 --> 0:16:53.840 a decrease in output. And then we look across firms 0:16:53.840 --> 0:16:56.480 and we show that more credit constraint, firms raised prices 0:16:56.480 --> 0:16:59.640 more and cut output, more, cut employment, more cut investment, 0:16:59.720 --> 0:17:00.960 more inventories more. 0:17:01.760 --> 0:17:04.400 All right, let's talk about the data that you collected, 0:17:04.440 --> 0:17:07.280 because it's a good story, right that. Okay, the money 0:17:07.480 --> 0:17:11.000 leaves the banking system, supply of credit therefore becomes ration, 0:17:11.600 --> 0:17:13.879 and then you have all these supply side constraints and 0:17:13.920 --> 0:17:16.359 that contributes to inflation. It's a good story. What is 0:17:16.400 --> 0:17:20.000 the actual data that you looked at to establish your claim? 0:17:20.280 --> 0:17:22.680 So there's there's the aggregate part of the data, which 0:17:22.680 --> 0:17:25.959 I think is important to see, but for economists usually 0:17:26.320 --> 0:17:28.960 can't by itself be convincing because you're just looking at 0:17:28.960 --> 0:17:30.479 the time series for the whole country. 0:17:30.520 --> 0:17:32.719 Wait, you can't do economics just by like looking at 0:17:32.720 --> 0:17:33.560 two big charts. 0:17:33.800 --> 0:17:34.479 I think you could do. 0:17:34.640 --> 0:17:35.800 I've made my whole career on that. 0:17:35.960 --> 0:17:38.960 I think. Actually that's a lot of times very important 0:17:39.000 --> 0:17:41.320 and the most convincing thing to people. But if you 0:17:41.359 --> 0:17:44.720 are in the business of being the you know, a skeptic, 0:17:44.800 --> 0:17:47.040 then that is not going to be enough. So we 0:17:47.080 --> 0:17:49.240 look at a lot of aggregate things, So looking at 0:17:49.240 --> 0:17:52.440 how deposits flowed out whenever the ceiling was binding, they 0:17:52.440 --> 0:17:54.679 flowed out more when it was when the gap between 0:17:54.680 --> 0:17:56.440 the fems right and the ceiling was more. We looked 0:17:56.440 --> 0:17:59.600 at unfilled orders or backlogs of orders that rose during 0:17:59.600 --> 0:18:01.959 that time. So I don't know which of these you 0:18:02.080 --> 0:18:03.960 find the most compelling. But then, like I said the 0:18:04.000 --> 0:18:06.480 second part of the paper, we looked at the cross 0:18:06.480 --> 0:18:08.959 section of firms to say, okay, let's look at something 0:18:09.000 --> 0:18:11.879 that just compares firms that were more exposed to this 0:18:11.920 --> 0:18:16.000 problem versus less exposed holding constant things you know that 0:18:16.040 --> 0:18:19.880 are aggregate, like the fed's credibility, like oil shocks, any 0:18:19.880 --> 0:18:21.400 of these things that you want to try to difference 0:18:21.440 --> 0:18:24.280 out in order to just focus on exposure to the 0:18:24.320 --> 0:18:27.040 particular channel that you think is at work. 0:18:27.400 --> 0:18:30.760 So just to be clear, we're talking about disintermediation and 0:18:30.840 --> 0:18:33.720 the idea that money can flow out of banks because 0:18:33.760 --> 0:18:36.080 they can't compete on deposits, and then that could lead 0:18:36.119 --> 0:18:41.600 to less investment. But what about just savings itself, Like 0:18:41.760 --> 0:18:47.200 how does REGQ and the deposit rate cap impact people's 0:18:47.240 --> 0:18:50.960 behavior when it comes to spending versus savings? 0:18:51.119 --> 0:18:54.679 Right, that apps actually the first line of reasoning that 0:18:54.720 --> 0:18:56.840 we went through. So we actually had two papers on this, 0:18:56.920 --> 0:18:58.600 but I'm talking to you about the supply one, but 0:18:58.600 --> 0:19:00.600 I'll tell you about the demand one. So that also 0:19:00.640 --> 0:19:04.119 makes inflation worse because so both effects go in the 0:19:04.119 --> 0:19:06.240 same direction, which I can tell you in a second 0:19:06.400 --> 0:19:08.840 how that happens. So if you want to if you're 0:19:08.840 --> 0:19:10.840 thinking about saving, and let's say that for you, the 0:19:10.920 --> 0:19:13.920 marginal saving is deposit, which for people at that time 0:19:14.080 --> 0:19:15.960 and even today a lot of people, it is. And 0:19:16.000 --> 0:19:17.760 you see the rate and you see that you're getting 0:19:17.800 --> 0:19:20.600 a terrible real rate, right, it's way below the inflation rate. 0:19:20.640 --> 0:19:24.000 At times it was seven eight nine percent below inflation 0:19:24.119 --> 0:19:25.960 because the cap was like five to five and a 0:19:25.960 --> 0:19:29.240 half percent. Inflation was fourteen percent at one point. That's 0:19:29.280 --> 0:19:32.680 just a complete disaster. So that on the margin would 0:19:32.680 --> 0:19:35.399 push you to try to consume, not to save. So 0:19:35.640 --> 0:19:38.560 if anything, it makes people want to consume more. At 0:19:38.560 --> 0:19:41.080 the same time, and for the same reason, there's less 0:19:41.119 --> 0:19:43.960 credit to firms, so they can't produce as much. Both 0:19:43.960 --> 0:19:47.439 effects go in the direction of higher prices. The production 0:19:47.480 --> 0:19:51.200 effect lower supply. The demand effect increases you know, would 0:19:51.240 --> 0:19:53.960 increase by itself total output. But both of them are 0:19:54.119 --> 0:19:57.160 making inflation go higher. So it's kind of a bad 0:19:57.200 --> 0:19:58.840 situation in that respect. 0:19:58.800 --> 0:20:00.200 Right, And it kind of gets to the heart part 0:20:00.200 --> 0:20:03.040 of how transmission of monetary policy is supposed to work. 0:20:03.119 --> 0:20:06.920 Because you're supposed to propagate these interest rate changes out 0:20:06.960 --> 0:20:10.080 into the system. Rates go up, people are supposed to 0:20:10.119 --> 0:20:12.119 hold on to more of their money. But if you 0:20:12.200 --> 0:20:15.359 have a deposit rate cap, then that isn't happening. 0:20:15.680 --> 0:20:18.439 Yeah, so usually so a sign of what microeconomists think 0:20:18.480 --> 0:20:20.960