Fed ‘in a bit of a box’ when it comes to inflation, economist says

University of Texas at Austin Professor of Government James K. Galbraith joins Yahoo Finance Live to discuss U.S. inflation, the expectations for Fed Chair Powell’s discussion on Tuesday, Fed policy, and the outlook for the economy.

Video Transcript

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BRIAN SOZZI: All right, inflation is slowing down, fueled by decreasing gas prices and an easing supply chain. But what does this mean for recession chances? Let's bring in James Galbraith, University of Texas at Austin Professor of Government. Good to see you here this morning. So we've been talking about really all week long, going back to last week after that Fed presser, the concept of disinflation. In what you study, do you see disinflation in various parts of the economy?

JAMES K. GALBRAITH: Well, it's clear inflation has been slowing since last July. This is not a new thing. It's now a well-established six-month phenomenon. And indeed, the Fed's own staff basically predicted this all well over a year ago. So the Fed is now in a bit of a box. They bought into the story that inflation was going to be persistent. It hasn't been. They could claim victory, but that would basically show that they were wrong in the analysis that they committed to at the start of last year. So the most likely thing is that they will be persistent in the policy that they're now locked into, even though the economic conditions no longer justify it.

JULIE HYMAN: Professor, you've done some interesting research on the bias of the Fed and what is supposed to be, of course, an independent organization. So how does that feed into what you're talking about, the fact that they'll stick to their guns even if, perhaps, the evidence would push them in a different direction?

JAMES K. GALBRAITH: Well, the Fed is independent of the executive branch. It's not an apolitical organization. The people who are appointed to it have political affiliations. Typically, Republican chairs are reappointed by Democratic presidents. And the result of that is they tend to be quite a bit tougher on Democratic administrations than on Republican ones. I don't think we're necessarily seeing that yet because we're not quite yet in the presidential re-election year. But that is something to bear in mind looking forward.

BRAD SMITH: OK. And so once we do enter into the throes of the political cycle all over again, you're going to have an economy that, at what point, who really knows exactly the extent of the Fed's policy that has been fully ingested by the economy and at what point we could see even more of a shift there. What's the timeline that you would be tracking as we get on later into that political cycle?

JAMES K. GALBRAITH: Well, I think we have to wait and see what happens this year. The Fed is locked into an inverted yield curve, which is typically an indicator of trouble. And they are, as your reporter just said, they haven't been anticipating a very strong jobs reports, which are not bad news. In fact, it's excellent news. There's no wage pressure. Wages have not increased above the rate at which prices have been increasing.

So all of that is not a reason for a tight policy. But can they back off from a tight policy under this-- given the way that Chairman Powell has said that the wages are his concern, tight labor markets and so forth? I don't think they're in a position to back down. So we shall see over the course of the year whether the strong job situation comes to an end, and then we'll have to take it from there.

JULIE HYMAN: So when all is said and done here, do you think that we will, indeed, enter a recession? The hopes for a soft landing seem to be springing up last week, it felt like. But is that a realistic scenario?

JAMES K. GALBRAITH: Well, I'm going to avoid forecasting, since it's a way of making oneself look foolish. But there is no history of soft landings in consequence of a tight monetary policy. They always just go on and on until households can no longer absorb new debt, and then there is a financial crisis. That's the way these things end, unless the Fed decides to back off. But as I say, I think they're basically in a box where they can't do that.

BRAD SMITH: OK. So forecasting aside, do you believe that there are parts of the consumer situation right now that are already feeling the effects of a recession?

JAMES K. GALBRAITH: Oh, sure. I mean, the construction sector has already been hit hard. As you can see, the stock market's been hit. Cryptocurrency's been hit, for what that's worth. But the construction sector is the big one, and you can see that housing starts are down. And that is a consequence, in part, of the tight monetary policy that we're already seeing.

JULIE HYMAN: Professor, thank you so much. James Galbraith, the University of Texas at Austin professor.

JAMES K. GALBRAITH: My pleasure.

JULIE HYMAN: Appreciate it.