In any economic crisis, whether deflationary like 2008 or inflationary like today, a policymaker's most crucial asset is their credibility. Fed President Austan Goolsbee shares this lesson from former Fed Chair Paul Volcker, warning against making promises or statements that could be proven wrong, as it makes managing the crisis significantly harder.
The current housing affordability crisis is not a recent event but the result of a long-term structural shift. For over 25 years, the relative price of housing has compounded at 5% per year compared to goods like electronics. This massive, decades-long divergence explains why housing feels historically expensive while many consumer goods are historically cheap.
While the Fed's official mandate targets hard data like inflation and employment, qualitative 'vibes' from conversations with business leaders are a critical input. A CEO's concern about rising lubricant costs impacting their business in four weeks is a real-time signal that can foreshadow future economic reports, bridging the gap between data and intuition.
Even as recent inflation surged, market expectations for inflation five years out remained stable at the Fed's 2% target. This demonstrates the power of the Fed's credibility. If the market loses faith, it can trigger a self-fulfilling wage-price spiral, making it much more painful for the central bank to rein in inflation.
The Fed's power comes from the 'divine coincidence': the most cyclical industries (like construction) are also the most sensitive to interest rates. This allows the Fed to use rates as a 'volume knob.' However, stagflation (high inflation and high unemployment) breaks this link, creating a policy catch-22 with no obvious playbook, making it a central bank's worst nightmare.
Rather than aligning with a fixed policy bias like 'hawk' (favoring higher rates) or 'dove' (favoring lower rates), Austan Goolsbee describes his approach as being a 'data dog.' This philosophy involves sniffing out every piece of information available, including alternative datasets like online price indexes, to form a more complete and unbiased view of the economy.
The concept of 'Fed independence' has a narrow, critical meaning: the sitting government cannot dictate monetary policy. It does not mean the Fed is unaccountable. This separation is based on empirical evidence from countries without it, where political pressure on interest rates consistently leads to runaway inflation.
A significant, overlooked driver of housing unaffordability is that the construction industry has become less efficient over time. Fed President Austan Goolsbee notes that construction productivity has actually been negative for the last 40 years. Unlike other sectors that innovate, we are getting worse at building, which directly contributes to higher costs.
The Federal Reserve's decentralized structure is a deliberate feature, not a historical accident. It was created to ensure the entire country's economic perspectives were represented in monetary policy, countering fears that a single central bank would be controlled by the federal government and New York financial interests.
While current events may push the economy in a stagflationary direction (higher prices, slower growth), it's crucial to distinguish this from actual stagflation. Goolsbee notes that the 1970s saw unemployment and inflation rates both near or above 10%, a scenario far more severe than today's challenges.
Although the Federal Reserve's interest rate decisions are made by a 12-person committee, the Chair holds disproportionate power. They are not just one vote among equals; they determine what policy options are on the table and frame the primary proposal that is ultimately voted on, heavily influencing the final outcome.