Defying Trump’s demands, Federal Reserve Chair Kevin Warsh announced yesterday that the Fed would raise interest rates for the first time since 2023. Reminding us that economic policy shifts are not unusual in an evolving economy, Professor and economist Justin Wolfers points out that “if you think nothing’s happened in the economy over the past three years, you were probably asleep.”
Wolfers joined Jen to put this week’s Fed news in simple terms. He explains how Warsh chose between Trump and Wall Street, why language matters in monetary policy, and what effects yesterday’s news will have on global trade.
Justin Wolfers is a professor of public policy and economics at the University of Michigan. He hosts the Platypus Economics podcast.
The following transcript has been edited for formatting purposes.
Jen Rubin
Hi, this is Jen Rubin, Editor in Chief at The Contrarian. Delighted to have back economist Justin Wolfers from Michigan. Welcome, Justin, good to see you.
Justin Wolfers
You too, mate.
Jen Rubin
After 3 years, the Fed has now raised interest rates. Why did they do it?
Justin Wolfers
When the economy changes, the right settings for interest rate change. If you think nothing’s happened in the economy over the past three years, you were probably asleep. So, look, let’s start with the good news, which is… so the Fed’s meant to care about two things, unemployment and inflation. Let’s start with the good news. Unemployment’s been pretty stable for about 3 years. It’s been stable, and it’s been low. It’s low relative to our history, it’s low relative to other countries. Let’s celebrate our economy as our labour market is mostly working. What that means is there’s no reason for the Fed to be keeping interest rates low in order to try and take care of this. What’s going on over the other side is inflation. We had a very steep pandemic inflationary burst, and then inflation was coming down. And then over the past year and a half, it’s basically flatlined, maybe risen, depends how you look at it. But the sense that it was automatically returning back to where the Fed wants it of 2%, that sense has dissipated, and I think the patience of the American people has pretty much gone, too. So that says, if you’re worried about inflation, you typically try to raise rates a little bit to rein in inflation. There’s actually reasonably good arguments either way, whether you should do it or not, but, in this case, it seems there was enormous agreement that we should raise rates at least a little bit. And it’s worth noting something, Kevin Warsh used fancier language or used simpler language. The way, which is…he doesn’t regard himself as putting his foot on the brake. He thinks what he’s done is taken his foot off the accelerator. That might tell you something about what’s coming in the future. If you think that high inflation requires a tap on the brake. Then that tap on the brake might be coming over the next few months as well.
Jen Rubin
Usually, I find it difficult to blame presidents for large economic trends, because, truth be told, friends. The president doesn’t have a little button on his desk for the economy. In this case, this president has done a bunch of stuff that arguably has made inflation worse, or at least prevented inflation from coming down to that 2%. Do you agree? And if so, what are some of those things that Donald Trump has been up to?
Justin Wolfers
Yeah. Look, my job for the first 20 years of my career was, if I were to talk to people on political shows, they’d all be like, why’d the president do this? And it would be like, he didn’t do everything. And I always had to use he, because that’s all we’ve had so far. I’m looking forward to a Sheila, that’ll be lovely. But… Let’s come back to the point. Sorry, I got distracted. I have stopped saying that. I’ve stopped saying it’s not the President’s responsibility. Let’s think about what’s driving the current inflation. Overwhelmingly, it’s the price of oil. The price of oil, overwhelmingly is due to developments in the Middle East, partly the closure of the Strait of Hormuz, increasingly the closure of a Saudi pipeline. All of this comes from… None of this was a problem 6 months ago. And then we decided to invade Iran. And then we learned that Iran holds an important chokehold not over a strait, but actually over the global energy market, and therefore the global economy. So, without a doubt, every part of the energy inflation is directly a response to choices the President made. And then we’re also still seeing higher prices due to tariffs. So that, again, directly, that’s a set of choices that the President made. But I also think that’s not just it. The President worked very hard to undermine the Fed. He tried to fire several Fed governors. He, even yesterday, is still talking about interest rates should be 1%. Well, if you were to lower interest rates to 1%, that would be lunacy that would create enormous inflation. And the very possibility that inflation might be high leads people to start making plans as if inflation might be high. It creates that reality. So that’s part of it. And then if we were to talk about the cost of living more generally, when you run huge deficits, you get very, very high interest rates, so we’ve seen This gets talked about at the moment as bond yields and the Treasury market and so on, but really what it comes back to is people’s mortgages. Mortgage payments are going to be harder to make. You can then, if you wanted to go beyond inflation to the cost of living, if you boot millions of low-income people off food stamps, which we now call SNAP, they’re gonna find it harder to get by as well. So, for a bloke who was relentlessly focused on reducing the cost of living from day one. I can name exactly one policy which is implemented to reduce the cost of living. It’s that he eliminated certain tariffs on beef, because beef got expensive. The president actually understood he has some direct effect on prices. When he wants lower prices, he reduces tariffs, but when he raises tariffs, he tells us it has no effect on prices.
Jen Rubin
I would also mention that with the labor market throwing hundreds of thousands or millions of people out of the country is not great economic policy either. Let me ask you about exactly that. He made this bizarro statement, 1%, and then he said something even stupider, which was, I’m gonna cut off trade. He’s made this threat before with any country with which we have a trade deficit. I don’t think he understands what a trade deficit is, but put that to the side. When investors hear that, when the bond markets hear that, does it become harder for Kevin Warsh to do his job to increase confidence that inflation will come down?
Justin Wolfers
Yes and no. Okay, so the really good thing that came out of yesterday’s press conference is, I think Kevin Warsh woke up with a very hard day yesterday. He could raise rates, which would have upset 1600 Pennsylvania Avenue. And he was widely expected to raise rates. Wall Street thought it was a 92% chance. And so you might say, what was the other 8% about? And I think there was an 8% chance that they’re like, well, maybe this bloke’s actually a sock puppet. If he hadn’t raised rates, he would have said, I’m a sock puppet. That would have caused Wall Street to freak out. So the question Walsh faced yesterday was whether to cause a freakout at Pennsylvania Avenue or on Wall Street. Yours and my lives are actually much more tied to Wall Street. I mean, our lives are tied to Pennsylvania Avenue, but… They’re not tied to the President’s feelings. And so he made the right choice. He made the right choice for the American people. he sort of showed himself to be a serious central banker yesterday. I hope I’m not over-extrapolating. And what that then does is it insulates our understanding of what the Fed’s doing from the idiocy that occasionally gets set. And… I don’t like to be a name caller, and I tend not to call… I tend not to be a name caller, but the President’s recent statements have gone beyond bizarre. if they were to be taken seriously, would be among the worst economic policy in the history of the United States. And what Kevin Warsh showed is they’re not going to have an effect on the Fed. So, there’s two things that he said… There’s so many things he said. But, one, the President’s still calling for interest rates to be 1%. I want to be clear. I think that’s a bad idea, because I think Trump’s okay. Let me explain. Why would we cut interest rates to 1%? If the economy were tanking, Unlike the president, I think the Trump economy is not tanking right now. I don’t think we need emergency rate cuts at this current moment. So, like, it’s truly bizarre to call for this. I can give you an intuition for what’s going on there. So, one is, real estate developers always want low interest rates. When rates are low, people can afford to build. And he probably wants more building going on. The second intuition is if rates are low. You and me, our credit card rates are lower, and therefore there’d be less of a monthly credit card bill to pay. Federal government’s like that. If the federal government pays lower interest rates, then there’s more money left for the president to splash around doing stuff the president wants. Now… So that’s a very understandable call for lower rates. Now, the problem is, this is a word… word for the day, fiscal dominance. This is when what you do is… today, and for decades, the United States has said, we want the Fed to set interest rates to get rid of the ups and downs in the economy, and to keep inflation low and stable. You could say, I want to give up on that game. And what we’re gonna do is set the Fed printing money. To support, to make it easy for us to repay our debts. What that would do, it would succeed at making it easy for us to repay our debts. But you’d see inflation go bananas. And we’ve seen this play Play out in many tin-pot nations around the world. I’m not in a hurry to join those. But I do have a deep fear that the President wants to move us toward fiscal dominance. And again, then, I’m actually quite pleased that Kevin Warsh is standing up to that, so today is a somewhat happier day.
Jen Rubin
Fair enough. Last question.
Justin Wolfers
Jen, wait, no, Jen, I forgot!
Jen Rubin
Yes!
Justin Wolfers
That was only list item 1 on the list of totally bizarre things.
Jen Rubin
Oh, yes, we forgot! Cutting off trade to anyone with whom we have a trade deficit. Trade deficit, folks, simply means we are selling… we are getting more bicycles, and they’re getting more dollars. That’s what a trade deficit is. I have a trade deficit with my dentist. I have cavities. I have fillings. He has my dollars. That’s a trade deficit with my dentist. I don’t stop going to the dentist.
Justin Wolfers
Right. So, this was… the president said, and he actually said it twice, he posted it once on social media, which one.
Jen Rubin
Yeah.
Justin Wolfers
at least when I type, I think, before I hit enter. And then actually, in a press gaggle, he repeated it again. He said, if the Fed raises rates, I’m going to cut off trade with certain countries. Now, if any of the audience at home is thinking, wait a minute, did I miss something in economics? How is cutting off countries from trade got to do with Kevin Warsh and the Fed? The problem is not you.
Jen Rubin
It’s not you.
Justin Wolfers
At all. So… What he’s doing is basically saying. Kevin Warsh, I’m gonna do something utterly absurd and hurt the American people. Unless… you do what I want. Now, yesterday, Kevin Warsh didn’t do what he wants, but just realize, the President is threatening to destroy yours and my economy. And our well-being, unless the Fed Chair does what he wants, which is bananas. The president said this twice. Now, this is one of the persistent problems for the president, which is no one takes him seriously anymore. Including the Federal Reserve Board, which is, if this were a serious threat, I actually think… if I were offered the choice cutting off trade with a bunch of countries or lowering interest rates, I might think about lowering interest rates, to tell you the truth. I would also think that was a shitty set of choices. So Kevin Warsh actually raised interest rates and dared the President to follow through, and the President has not followed through because he bellows loudly and does very little. But this was an utterly absurd thing. Here’s what worries me more. The federal government has immense power. Often the way we use our power is we threaten to use it rather than actually using it, right? You say to a country, do the right thing or you’ll be in trouble. If they understand you, they do the right thing and we don’t go to war. But if you constantly say nonsense. they might not roll over, in which case you’ve weakened American power unless you actually go and have the war. This is another case of a president making a high-stakes threat. And walking away from it almost immediately. So, he is spending destroying American power. By doing this every day. Let me add one more thing. The President, and this is the point that you were making, Jed, the President has said, on the flip side, what I’m going to do is cut off trade. With certain countries. To be clear, cutting off trade is not a 10% tariff or a 20% tariff, that’s an infinity percent tariff. Great, so now we’re moving to infinity tariffs. And he said it’s because we run trade deficit with those countries. And this is where I… I wanted to come back to this, Jen, because I want to echo your very smart way of thinking about it, okay? I bought this shirt from a company in China. So what happened is, US dollars left my wallet, But cotton left China. And so, in that transaction, there’s a dollar deficit. I sent more dollars to China than it sent to me. But there’s a cotton surplus. It sent me more cotton. Than the other way around. And once you understand a trade deficit is, in one direction, a dollar deficit and a goods… a stuff surplus. And by the way, these are literally linguistic conventions. It would be utterly appropriate for you to say. Jen, that you have a trade deficit with your dentist and a service surplus, a cavity surplus. I mean, I don’t like that because no one wants cavities. it would be just as appropriate for America to say we have a stuffed surplus with China, and what they got in return was pieces of paper with dead pres… with dead people on them. These are exactly the same thing. The president calls that a loss. I don’t. I call that a trade. And that word matters a lot, and maybe my tribe of economists has a lot to blame here. People hear the word deficit, and it sounds bad, right? Let’s be clear, I have emotional deficits, and that does not make me a particularly attractive partner. But what if we did instead? And so that word, deficit, does sound bad, and so what if we called it the difference, right? So, I think you and I can agree that I actually probably do have emotional deficits, but a different answer is that you and I have personality differences. Now we understand Jen has some strengths, Justin has some strengths. Jen has some weaknesses, Justin has some weaknesses. The word difference now… is no less accurate. In fact, it’s more accurate, because the reality is, some of your differences are strengths, and some of them are weaknesses, and the same is true for me. And likewise, when I bought this cotton shirt from China, that’s because we had differences. I had American dollars, and they had cotton. And their val… the fact that they have cotton, I think of as a strength. And the fact that I had the ability to buy cotton, I think of as a strength. It’s all language at the end.
Jen Rubin
Absolutely. Now, I will leave on this. First of all. Don’t spend that $5,000 bribe that you’re gonna get for voting in Republicans. First of all, they’re not gonna get elected. Secondly, there’s no $500,000 check ferry out there. But, my last question to you and our… Two minutes that we have left. Are we gonna get another rate increase at the end of the year? There seemed to be a lot of hinting about that. And is that now baked into the expectations on the inflation and the investment landscape?
Justin Wolfers
Great. So I always… I’m gonna start by giving a little economics lesson. You’re always better off getting… the guidance of a market than any individual economist, because I’m not smarter than the market. So what I’m going to do is, I’m not deflecting, I’m saying I think the best answer is what the markets think. By the way, that’s an example of a humble economist. They’re rare. A Wall Street guy will tell you exactly what’s going to happen. So, markets think there’s a 50-50 chance of a second rise before the election. So before October. And I think, actually, the before the election part is doing a lot of the work there. If you go out to before the end of the year, they think it’s a 90% chance we get another rate rise. And in fact, there’s a reasonable chance we get two more rate rises this year. Kevin Warsh isn’t talking much about it, because he doesn’t believe in forward guidance, but if you listen, you can still hear.
Jen Rubin
That’s what he thinks.
Justin Wolfers
And the rest of the Federal Reserve Board’s been very clear about that. So, strap in, we have more rate rises coming. And actually, at some level, I think it’s obvious enough, I wonder what… Why we’re gonna move so slowly towards it.
Jen Rubin
Well, we will have more conversations, and we can, in those conversations, discuss why Kevin Warsh is so averse to guidance. I like guidance. I’m the kind of person who goes to the end of the book to find out, like, how it ends. I don’t like all that tension. I want to know where we’re going. But we’ll leave that for another day. Justin, thank you for making very complex things seem very simple, and by the way, nice shirt. I like it. Take care. We will see you next time. Thanks so much.
Justin Wolfers
Thank you.
