Talking Again With Claudia Sahm

The fight over the Fed and more

The Federal Reserve has been in the news, for all the wrong reasons, with an obviously political criminal investigation into Jerome Powell, the Fed chair. So I thought it would be good to talk again with the inimitable Claudia Sahm about what it means. Transcript follows.

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TRANSCRIPT:
Paul Krugman in Conversation with Claudia Sahm

(recorded 1/15/26)

Paul Krugman: Hey, everyone. Paul Krugman again and talking again with Claudia Sahm, who’s one of my real go-tos and a tremendously influential voice on macroeconomics. I’ve been looking at the Real Time Sahm Rule series on Fred, which is where those blue background charts on my Substack come from. Claudia’s my favorite Fed expert, or one of my favorites. Hi, Claudia. I thought we could talk for a bit about what’s been a pretty eventful week. Obviously on many fronts, but certainly in the Fed area.

Claudia Sahm: Happy to be back and to have this conversation. Sad that we are having the conversation and that it’s necessary, but it’s important to unpack it and see what this possibly is.

Krugman: Before we get into the criminal investigation of Jerome Powell and all of that, there’s also the state of the economy that is kind of interesting—that’s like when my mother had a recipe that failed my father would say it was “interesting”—but anyway, the state of the economy is interesting. Depending on which data you look at there are different conclusions or different stories that people tell. So what do you think is going on with the labor market?

Sahm: First, I’ll start with what I don’t think is happening. I don’t see a recessionary dynamic in the labor market, but that actually is a pretty strong statement, given the fact that we saw job creation really fall off a cliff last year. Frankly, it had been slowing for some time. So this is not just about last year, but job creation is very low in the United States, and we’ve seen the unemployment rate move higher. The jobs aren’t keeping up with the people who are out there looking for work, but this doesn’t look like our typical business cycle.

The unemployment rate drifted up last year, but it drifted up the year before as well. We are a full percentage point off the lowest point of the unemployment rate in the cycle, which was close to 3.5%; you look back all the way in the post-World War Two period, that has never happened. We’ve never had that much of an increase in the unemployment rate and not gone into a recession. But this is very different, it’s been very gradual. It’s not really picked up and gone from a slow increase to a really rapid increase that would be normal, so it is puzzling. At the same time, this past year, we’ve seen economic activity continue to expand. Those GDP numbers, they might overstate the case of how much strength there is in consumer demand and business investment, but they look pretty good. You have a really unusual set of signals from the economy. At a moment like that everyone at the Fed ought to be totally focused on “how do we interpret the economics”, “what’s the right interest rate”; there could be policy responses that go way beyond the Fed or tax cuts.

I’m very concerned about what’s happening in the labor market. It’s hurting people coming in. Young people looking for jobs, people on the margins looking for jobs—there’s some problems here, but we need to really focus on the economics of it, unpacking it. We don’t have the usual go-tos because it doesn’t look like historical periods. Then we have a moment where politics just floods in.

Krugman: We’ll talk about the politics in a minute, but for what it’s worth, that Real Time Sahm Rule indicator—let’s not go through what the indicator is again—but .5 was your criterion, it’s .35 now, which is kind of a little bit worrisome. But on the one hand, it doesn’t feel like that. Or it doesn’t look like, as you say, a recessionary dynamic. On the other hand, it’s extremely difficult to get a job. So if you have a job, we’re not having mass layoffs, but as you were saying, people do get laid off one way or another still, and even if it’s not en masse—then it’s really hard to find a new job. There’s a lot of debate about what’s going on there.

Sahm: I think this has been a real lesson. The problem in the labor market right now is a very low rate of hiring, the problem is not layoffs. Often we think, “layoffs, that’s the big problem. That’s the recession.” That’s why we get agitated and you say, “oh, there have been layoff announcements,” but we’re not actually seeing people losing their jobs. Jobless claims are not really up that much. So “oh everything’s okay,” right? But in fact a low hiring rate can be very problematic because over time as new workers come in and people who finish their education, whether it’s high school or college, other training, they really struggle to find jobs. So their underemployment rises, and that can be a big problem, not like in kind of a business cycle recession problem, but not bringing people in at their full potential, that we could pay for over a long period of time.

It is hurting groups on the margins of the labor market. We’ve seen the black unemployment rate really move up in the past year. So it’s not about layoffs. It’s about this low level of hiring. I think again, back to what’s happening in the broader economy, it’s kind of puzzling. It’s not that businesses don’t have the customers, it’s not that they aren’t making profits, they’re just not hiring. There could be a lot of explanations for it. But it’s an unusual problem, and just the fact that layoffs are happening or they’re still very historically low, that’s not a “coast is clear,” right? There’s still an issue for policymakers, but it may not be just as simple as cutting interest rates and doing tax cuts.

Krugman: Yeah it’s this kind of—freeze. So if you don’t have to move—in terms of jobs, you’re doing okay. But it’s really terrible. I have been sort of saying, “extreme policy uncertainty”—it’s a story, it’s probably the simplest story, but we don’t really know. As you say, it would be really something to try to figure out.

Sahm: There could be an explanation as simple as: early in the recovery from the pandemic, we had a very dynamic labor market; we had workers moving jobs, we had labor shortages, we had wage increases. It may just be the slower hiring now is a reflection of the fact maybe there was some over-hiring before, businesses have kept workers longer. People get more productive when they’re on the job longer. So there may be just this normalization. We had a job-full recovery in the beginning, which was unusual for the US in many decades, and we have shifted into a jobless expansion. It may just be part of the normalization, but it is worrisome, and particularly as it drags on.

So then there’s a question, is it uncertainty about the political environment? Is it uncertainty about technological changes that might be affecting the workforce? I don’t think AI can explain where we are right now in the labor market. We haven’t seen the diffusion of those technologies, but it could be holding back businesses from hiring. There’s a lot of possibilities here. But it’s a slower moving problem than a recession. But that doesn’t mean that it isn’t a problem and deserves potentially a policy.

Krugman: Policy response, but maybe not monetary policy response. It’s as you said, it’s maybe not something that cutting interest rates could solve.

Sahm: It may be. The Fed took action last year, right? They cut the Federal funds rate by 75 basis points over three successive meetings, despite the fact inflation was still elevated. We really didn’t make any real progress on inflation last year. Complicated situation: upside risk to inflation, downside risk to employment, and they stepped in. I think it was appropriate by saying “the labor markets are not in a bad place right now, but there’s a chance that this gets much worse. So we need to act preemptively, take out some insurance.” That was the path the Fed took. There were disagreements even at the Fed over what’s the right thing to do. But they’ve taken out the insurance, and we’re coming into the year where there are some tax cuts to households and businesses coming online, which also ought to give some support to stabilize the labor market.

I think the Fed is going to want to see their actions play out, see what these tax cuts do. So we’re kind of in a wait-and-see. I’m cautiously optimistic that we’ll see the hiring rate stabilize and move up, given the support from the Fed and the tax cuts. But if there’s something deeper, this uncertainty—I think we’re going to learn a lot about the labor market early this year. If there are deeper problems, more structural problems. Well, then that’s not where the Fed has very effective tools. That’s a different kind of conversation.

Krugman: People insisting that that stuff is structural and can’t be fixed by monetary policy, that’s been abused so often in the past, but this actually looks like it. This does not look like a simple problem, that “money is too tight.”

Sahm: The Fed should use the tools they have; the Federal funds rate, they have plenty of room to cut. Their dual mandate is maximum employment and price stability. If employment is really starting to slide, the Fed should be stepping in. It’s just a question of: we want to resolve the problem, right? The Fed may not be the solution to the problem but it doesn’t, as you said, it wouldn’t excuse them from staying on the side—it doesn’t. They haven’t stayed on the sidelines, they are in the mix. Because this is such an unusual dynamic with the labor market and the broader economy, it just raises questions about: what’s the right lever to pull? Frankly, we ought to pull a lot of levers, take uncertainty out of the economy. I think there’s a lot of conversations around AI that could probably benefit the labor market. So the market should be trying lots of different things because even though the layoffs aren’t with us right now, this is a real problem that is going to build over time.

Krugman: This is a time when you would really want a lot of calm, detailed analysis—but won’t necessarily get it, this is why we have professionals at the Fed but that’s not what higher management seems to want.

So, what was your reaction? We know that there’s been a lot of hectoring of Powell and the Fed from the White House, but this astonishing criminal investigation, how did you feel about that? I mean, obviously you weren’t happy.

Sahm: There’s a lot to unpack from this week with the Fed. First, I’m deeply concerned about the ongoing escalation of pressuring the Fed to lower interest rates. Taking out a criminal investigation against the Fed chair is very serious, this is past using words to insult, this is a pressure campaign and it’s one that’s being used not just against the Fed. So there’s a really big issue with the actions that were taken by the Trump administration. I fully support Jay Powell coming out with a public statement and being very clear—using the words of the renovation, this is a pretext, right? Jay Powell’s two minute public video statement was extraordinary. He has stayed out of the politics. He has not said “the White House is pressuring us to lower interest rates” until Sunday and it was a very clear and direct and brief message unlike what usually comes out of the Fed.

One thing I really appreciate in his statement, Powell didn’t refer to the “Fed independence” or similar jargon. He laid out, very clearly, what’s at stake. Are interest rates going to be decided by evidence and economic conditions, or are they going to be decided by political interference and intimidation? This is not just about the Fed. Frankly, we’ve seen other efforts from the White House just in the last week to try to push down interest rates in other places—the president saying “credit card companies cut rates to 10%” just by edict. So really focusing on: this is not about the Fed. This is not about what we do in the institution, it’s about the economic outcomes that are going to affect people, because it might sound to everyday Americans, “lower interest rates are great.” Who wants to pay more in interest, right? If you’re a borrower, if you’re saving, you want interest rates to be higher. But you want experts who can play through: “what does this mean?” Not just on day one when the interest rates are cut, but what does this mean two years, five years from now in terms of economic outcomes?

I really appreciated Powell for calling out the politics. Calling out the escalation that’s been very clear and centering on: “what are we really talking about here, this is either about economic evidence or about politics?” There was a big outpouring of support, including from some congressional Republicans who are close to the president. This does not seem like this was a successful campaign, Powell did not back down. He did not resign. He is probably not going anywhere anytime soon. I find that, somewhat, this is good for the Fed. But I am deeply concerned that a lot of the outpouring of support goes back to—this is Jay Powell, this is an individual who is a lifelong Republican. He has worked in Republican and Democratic administrations. He is the last of the bipartisan Fed members. He was elevated to a governor at the Fed by Obama and then brought to being Chair by Trump and renewed in the chair position by Biden, the kind of credentials and support that he has built over decades of his career in Washington working in politics, also working in private industry. Nobody else at the Fed has that kind of backing. And so, if Jay Powell had three more years left on his chair and the president had four months, I’d be like, “okay, we’re going to get through this.” But it’s the opposite. Jay Powell is out in four months as Chair. The Fed is in a very precarious position.

Krugman: Just to say, you and I are accustomed to reading Fedspeak and know that this is not how central bankers usually talk. In fact, that statement by former Fed chairs was largely unreadable by normal human beings. But Powell’s statement was really crystal clear, which was totally amazing. This tells you in a way just how great the things are, because there’s a reason why central bankers usually avoid being too direct, so as not to rile markets and so on. But, what happens? Trump will replace Powell with presumably whoever he chooses—and we may want to talk a little bit about those choices, but presumably whoever he chooses will be chosen—at least in the White House belief—that he’ll do what they say and cut rates. But what actually happens? Because it’s not that simple, the Fed isn’t simply run by the dictat of the Chair.

Sahm: We’re at a place where the president is going to make his nomination for Fed Chair. This has been a long drawn out, “Fed Chair-Apprentice series.” So we don’t know who that person is yet. But president Trump has made a very unusual and I think very problematic statement that he’s not putting anyone up unless they are in favor of much lower interest rates. So again, this is not about the evidence, economic conditions, the president’s like “I want rates lower” and he’s only going to put people in that are committed to getting rates lower. There’s a lot of problems with that. But this person has to then get through Senate confirmation. It was really important that some of the first and very influential members of Congress who stood up for Powell this week, they’ll be instrumental in getting Trump’s nomination for Fed Chair in place as Fed Chair. And in fact, Senator Thom Tillis, who’s on the Senate Banking Committee said, “until this investigation is closed up, he’s not advancing any nomination to the Fed, including the chair.” So, again, Powell’s term as Fed Chair ends in May, it’s problematic, this is the time where things should be moving. So there could be hurdles in the Senate. But in all likelihood, I think we should assume that Congress is going to give the president who he wants as Fed chair.

The Fed chair, it’s a leadership position, it’s incredibly important, but at the end of the day, the Fed Chair has one vote. There are 19 Fed officials, 12 of them are voting, to move interest rates down, you would have to have seven votes. So a Fed Chair coming in committed to lower interest rates has to win over other Fed officials to make that happen. We already knew coming into this year there was a lot of disagreement about Fed officials, even with the rate cuts last year, that Jay Powell was able to lead the Fed through because there’s economic concerns. There’s a case that could be built, if the data come in to support it, that would lower interest rates. Powell has said, and many Fed officials, they expect the next move of the Fed to be a rate cut. They’re just waiting for more evidence in particular that inflation slows. So I do expect the Fed to cut interest rates. I think it will take some time. But the president wants rates down now, and down rapidly. I think there’s been a lot of worries about Trump putting a loyalist at the Fed and somehow this individual being able to strong arm other members, and they make an assist from the Supreme Court: if the president’s allowed to remove Lisa Cook and other members, where they can pack the Fed and get the votes, that may be the path around we’re on. That would be very bad in terms of interest rates, because ultra low interest rates are not what the economy needs right now.

But I think there’s another path that hasn’t been discussed as much is that we might have a very weak Fed Chair. We could have someone in who is a loyalist to the president, who uses the bully pulpit of the Fed—and the Fed’s got a big bully pulpit—to just amplify the White House economic messaging, isn’t able to build a consensus, doesn’t have the trust of other members and then can’t get interest rates down and then the president gets mad and steps in. The next Fed Chair may be the one that actually gets fired, because who’s going to stand up and defend the loyalist Fed chair? He’s not Jay Powell, whoever it is is not going to be Jay Powell and have the kind of respect. Moving interest rates around because of political reasons, that’s bad; a weak, ineffective Fed, where the only people who are willing to go work at the Fed are political loyalists who don’t have skills, that is an incredibly dangerous situation for us to be in because crises happen. Things happen in the economy, things happen in the financial markets, to have a Fed that isn’t on top of its game, that’s a really bad place for us to be. I think that a very weak Fed could be the direction we’re heading in right now. It’s hard to see how this plays out in a good way unless some of the guardrails of the Fed are strengthened. That has to come from the Supreme Court strengthening removal protections from Congress, taking its responsibility of putting independent people at the Fed. But until that happens, I’m not going to be optimistic about this.

Krugman: People have largely forgotten it, but in early 2000, as the pandemic’s magnitude became clear, we came very close to a really complete financial meltdown. Basically the Fed poured in liquidity—would a weak political pawn, ignoramus Fed Chair, have been able to do that? I worry about that.

Sahm: Last year, to see disagreement among Fed officials about what’s the right thing to do, I found that reassuring. The economy was complicated, like we were talking about, it’s really hard to read the labor market: “what is the right thing? What is happening with inflation?” So there are moments where disagreement is reassuring and we can handle that; in the moment of a financial crisis, to have disagreement blow up inside of the Fed, that’s a moment where we need forceful action, competent action, and we need the Fed to be helping bring down uncertainty, that is not a moment where you want a Fed in disarray. That’s what we might end up with.

Krugman: I was interested to hear you say something about who wants to work at the Fed. I’ll get there in a minute, but what was really striking with the criminal investigations, it’s really bad if the president fires officials because he doesn’t like them, which is what happened—we’ve almost forgotten now, but the Bureau of Labor Statistics, Trump didn’t like a jobs number, and he fired her, and which didn’t actually appear to have changed there, but the agency hasn’t been politicized, at least not yet. But, this is more than that. This is saying “we will destroy your life. You don’t go along with my policy stuff, I will ruin you.” That has to have a chilling effect throughout the government in general, but certainly the Fed. I’m hearing some rumbles that the personnel situation at the Fed is not great. But I don’t know if you’re hearing the same stuff.

Sahm: Well, it goes way beyond the Fed. I said some of the situation stabilizing this week really rested on Jay Powell. He talked about how he had decades of bipartisan support. He also is worth tens of millions of dollars, he worked in the financial industry for many years. The criminal investigation in the Department of Justice is opening, the Fed legal staff cannot represent Jay Powell. He has to hire private counsel and, according to reports, had retained private counsel even before this investigation. This is not a total surprise that we were headed in this direction, but for him, he has the money to do this. He said in his statement, “as a public servant, there are times where you need to take a stand.” This is true and I am heartened that he took the stand and he is standing firm, but he has the ability to take that stand that most public officials don’t. They talk about, “watch the resignations out of different agencies.” We should be incredibly concerned about resignations out of the Department of Justice. That’s one of many ways that threats of lawsuits—people who don’t have the ability to represent themselves, don’t want to take their family through that. They might resign or they may not even be willing to sign up, because they’re not going to be protected.

This is a really bad path that we’re on, and it goes well beyond the Fed. So I’m glad that Powell was able to take the stand. But not everyone has the ability to do that. The Fed has more removal protections than practically any other public servants. It is an independent agency. Congress foresaw that the Fed would be vulnerable to political influence, and over time, there’s been attempts to politically influence it. You mentioned the commissioner, the Bureau of Labor Statistics is often considered independent, run by experts, not a place that the politicians hang out, but the Department of Labor, that’s in the administration, it’s been on tradition and norms that protected that individual from removal. The president has not respected those at all. He’s going after people who actually have some legal protections on their jobs, like Powell. So it’s a situation that, again, goes well beyond the Fed. You really do need people who are skilled and competent and trusted in these roles, and they’re not going to be welcomed.

Krugman: The Fed has a lot of career staff, people who have basically spent their whole lives there and have been dedicated public servants and are not personally wealthy. So Powell, because of a more complex background and private sector and all of that does have some personal resources, but I would assume most of the people that you really need to make sense of these peculiar goings on in the labor market, for example, don’t have a backstop. So if we get into the level of: “the Justice Department will be weaponized against anyone who isn’t going along with the president’s agenda,” my God, the Fed pays a little bit better than the civil service, but still, who wants to be in that position?

This is from left field, but the Fed does more than set interest rates. It also does regulatory supervisory work. Do you have any sense of what’s going on with that side?

Sahm: This case of keeping politics out of monetary policy, the tradition of politicians deciding what interest rates are, has a support in history, both in the United States and globally. The Fed is taking something of a position that really protects itself from political influence on monetary policy, but that case—and I kind of disagree with this—but they’ve said, the Federal Reserve has a lot of bank supervision and some financial regulations where the Fed isn’t standing alone like on monetary policy. The Fed stands alone, it is the institution within the US government that is making decisions on monetary policy. But when it comes to bank regulation, it is one of a set of Federal institutions. So the Fed works with the FDIC, an office to control the currency. They kind of split up the banks, and on regulations they’ll work together. So it’s less clear, because it is all part of the administration.

As an example of this, Michael Barr had been the vice chair in charge of supervision at the Fed. He was put into that position under President Biden. He stepped down from that position early this year. He’s continued in his role, he stayed on as a Fed governor. He’s continued to give speeches about bank supervision, about financial regulation. But it is clear that his view of where the Fed should be headed, where those areas should be, is different from the president’s. But the Fed didn’t take a big stand on “Barr is going to stay in place,” and instead Barr resigned from the vice chair of supervision. Michelle Bowman, who had been nominated by President Trump in his first term, stepped into that role. She was confirmed by the Senate in that role. So this is a case where the direction that the Fed has gone in terms of supervision and its financial regulation is much more consonant with the Trump administration and their views. Which isn’t to say that it’s politicized, but you can see the Fed is drawing a line with monetary policy. There’s justification of why monetary policy should not be the purview of politicians, but they haven’t brought the regulation into that. We’ll see how that plays out.

I think that’s the other thing that’s so notable about this week: Powell coming out with this public statement and really calling out the political interference. There are many steps in the first year of the Trump administration where the Fed could have come out and taken a stand, and they didn’t. Michael Barr had pressure on him and he stepped down, Lisa Cook, the president tried to remove; the Fed didn’t take the stand until we got to this place and one can second guess those decisions and have different opinions about it, but the Fed has treated the supervision as different. But they’re still taking the job seriously. I don’t want to act like they’ve just handed over the keys. But you can definitely see different approaches and a much lower tolerance for the politics to seep into monetary policy.

Krugman: It’s interesting because supervision is always a funny thing, on the one hand it is highly technical; you really can’t expect a random member of Congress to be able to second guess those kinds of decisions, you really do want professionals. On the other hand, at some level, it is clearly in the political arena.

Sahm: The supervision of banks is so central and frankly, the reason that the central bank exists is lender-of-last-resort, stabilizing financial markets. Well, if you have that power, you want to make sure you don’t have to use it, which means you oversee the financial system and make sure it doesn’t get to that point. So the banking system, the financial system, that’s so core to having a central bank, not monetary policy. The financial stability really is important. But then, one could make a case that as you said, the bank supervision, maybe that really should just be a full time expert, maybe it should all be under the FDIC. Maybe it shouldn’t be across agencies. One of my worries is after the financial crisis in 2008, part of Dodd-Frank, it took a lot of the consumer protection responsibilities away from the Fed, because I think, very credibly, there were arguments made that the Fed hadn’t lived up to their duties in terms of protecting consumers that they really focused on the mortgage fraud, it just didn’t rise to the attention because the Fed had other things they were focused on. So you think, “oh, let’s take this and put it in an agency that’s all dedicated: The Consumer Financial Protection Bureau” which I think is a great idea, until it gets shut down.

Krugman: Just a word for listeners. Dodd-Frank was the reform that was put in after the financial crisis. It became clear that the existing regulatory structure, which was designed for banks, wasn’t adequate for this whole world of shadow banking. So Dodd-Frank took a lot of stuff out of the house, the Fed and the consumer financial protection Bureau. But CFPB had a lot of legal protection, it was designed to be invulnerable to what has actually happened to it.

Sahm: It hasn’t proved invulnerable. So it might make a lot of good economic sense or good procedural sense to have bank supervision outside of the Fed. But the Fed truly has extraordinary protections from interference. It has its own budget. It has removable protections that other agencies don’t have. It’s really tied into financial markets in a way that kind of gives it—I don’t think it’s the best backstop, but it does give it more protection than other Federal agencies. That kind of institutional framework is really important.

Krugman: A quick anecdote. The group of 30 — Paul Volcker used to be the chairman of that group. He looked at me during some meeting and said “Krugman, you’re looking pretty down. What’s wrong?” And I said, “oh, I just spent two hours listening to a bunch of men in suits talk about bank supervision,” which I thought was the most boring, impossible subject. I think it was 2007. A year later, inadequate bank supervision blew up the world. So I was wrong to be so bored, although it is inherently a deeply boring subject. But you’re right, there’s always a question here about how the Fed has a lot of institutional protection and professionalism, and so it’s good to have important stuff under that roof; but too much stuff under that roof, then it’s not the Fed anymore. And it’s no longer going to be treated specially. So this is a bit hard. But I do worry that in looking at the interest rate decision, we may be looking too narrowly at what’s under threat now.

Sahm: Another problem that I’ve seen, there’s been a lot of talk about reform of the Fed. Treasury Secretary Bessent has a long list of things that he thinks the Fed has done wrong or could do better. You’ve seen other Fed chair candidates mention similar things. I want to be clear, like the Fed is not perfect. I think there are big questions about how you have an independent agency where technocrats are making decisions that affect millions of Americans. They’re not elected, so then how do you have independence? But then also accountability: how do they report to Congress? Like where should the lines be? Because some decisions should be determined by politicians. It’s not that you just want the economists or the lawyers running the world, right? You have a political process. So there’s these big questions that have been since the very beginning of the Fed and will continue about how you could do it better as an institution.

Unfortunately, I have a hard time really joining in these “let’s make the Fed better” conversations because they also don’t feel like they’re motivated in terms of making the Fed better. It’s like trying to weaken the Fed, discredit the Fed. I am not convinced that the president is going to be able to move interest rates down. When we talked about a lot of reasons why the Fed just doesn’t pull rates down. I think the president is going to be very effective at weakening the institution, and probably already has. This is going to be a really big mess to clean up, even if it doesn’t blow up in some dramatic market movement. So that’s where some of these reform discussions aren’t about making the Fed better. They’re about making the Fed weaker, and that makes it more vulnerable to political intimidation.

Krugman: If you want to make a case for why politicians shouldn’t have their direct hand on the dial. It’s hard to do better than looking at Trump’s recent statements. I think just the other day he said “if the market is up, then we should cut interest rates,” because they seem to think of interest rate cuts as a gold star that you get for doing well on a class quiz, instead of as a management tool for managing trade-offs.

You probably can’t answer this, but maybe it’s a jumping off point: How bad can it get? Not in terms of how bad it is at the Fed, which I worry about to be a thing, because I have friends there, but how bad does it get in terms of the macro economy?

Sahm: We can go back and look at the last time the Fed was under incredible amounts of political pressure. There are some parallels in terms of where we are in the political calendar as well.

In his reelection campaign, President Nixon put a lot of pressure on the then Fed Chair, Arthur Burns. This was someone who he had worked with, had close ties to, and the Fed kept interest rates low in the election year. That was part of gooseing the economy, keeping it going, it’s good for an election—that history has been told, but if you go back and look at that moment, it wasn’t just about the Fed keeping interest rates down, there was a big push to get the housing market going. Lots of different measures. The levers that were pulled in the Nixon administration are different than today. But it has this spirit, you see, price controls trying to loosen up credit and the housing market, this big effort to really run the economy in a way that in the short term, was beneficial to people. Growth is good, housing market is up, stock market is up. Nixon was reelected. We know that Nixon was pulling levers outside of the economy too, with the reelection. The Fed was one piece in a much bigger puzzle.

We’ve looked, in the last week, the edicts, the proposals coming out of the president, they go broader than the Fed. “Cut credit card rates to 10% by next week. Do purchases of mortgage-backed securities,” you’re pulling a lot of different levers to get interest rates down, and the efforts to intimidate the Fed haven’t been successful up to this point, but they fit within a broader thing—but back to: why should anyone care about this? They’re going to push interest rates down, and try to run the economy hot. It politically worked well in terms of the reelection with Nixon. But the economy was a mess on the other side of that, as the price controls came off, as the interest rates and the inflation took off. That required us to get the inflation under control, which had been building over time, that took some really dramatic efforts from the Volcker Fed in terms of raising interest rates, a deep recession. So it did a lot of damage. We’ve seen this news, the other cases around the world, eventually you end up with higher inflation and you end up with financial instability.

Krugman: That’s something we aren’t talking about much, the financial side. The inflation side is sort of easy: single focus, that’s kind of one number, there’s one inflation rate. But the broader issue of financial stability, also an irresponsible politicized Fed which would contribute to that.

Sahm: Yes. For that it’s really event driven. It’s not like interfering with the Fed isn’t a guarantee that you get bad outcomes, you might not get bad outcomes right away. You might not get it later. We could get lucky in that: productivity has risen. It could really set in. We could be disinflationary. Having ultra low interest rates might be the right thing to do by the end of this year, next year. This is not my base case at all. But you could have events come together in a way that pushing interest rates lower doesn’t create excess inflation, doesn’t create instabilities. We might not have another kind of Silicon-Valley-bank-run-type issue. We might not have credit market problems or whatever. Then it’s like, “oh, this wasn’t such a big deal.” I think for markets, they haven’t reacted much to all this because we’re not really in a crisis moment. We’re not really depending right now on the Fed only getting it right. But bad events happen. It just dials up the risk because you don’t have a Fed, or just more broadly thinking about interest rates, thinking hard about: is this the best thing to do in terms of the evidence and the economic conditions?

Then you could make a really bad decision in terms of interest rates, and if that moment of financial disruption comes, you could just really botch it. Financial markets move fast. With the Fed, there have been multiple times where they kind of got things under control quickly, like over the weekend and it didn’t spiral out. Well, If you have a Fed that comes in and really botches the response, things could start spiraling out. So it’s not a guarantee that bad things happen and we don’t want to overdramatize it. But it’s like: what purpose does this serve in terms of the American people and the economy functioning to be putting this much pressure on the Fed? Really trying to push through a political agenda on interest rates that historically has not ended well.

Krugman: The Fed’s track record is not perfect. They called inflation wrong in 2021. But we didn’t get stagflation back. This is an institution we ought to be cherishing for being open-minded and having done stuff mostly right. And now instead, you have potential criminal charges.

Sahm: Another piece of the Fed that really is trying to engage with the data, the evidence, and the Fed gets a lot of criticism for not raising rates soon enough in 2021 as inflation is taking off. They did pivot in 2022. The Fed raised interest rates very aggressively to try and get that under control. So they were willing to shift gears, Powell has even said we could have moved sooner. You have individuals that have been willing to admit a mistake and change course because the date, like the economy says, we need to change course for as much as Powell-Fed is criticized for the inflation we saw in ‘21 and ’22, the Powell-Fed also oversaw a very rare occurrence of a soft landing. Inflation has come down—not all the way down—but it has come down a lot. The unemployment rate has risen some, but we avoided recession, this is not typical. I think part of that is—it’s not all about the Fed, The Fed does not run the economy—but it is really important to have an institution and people at the Fed who are willing to pivot and do what is right for the economy, not kind of stick to their guns of like, “well, I just know that we need to be doing x, y, z with interest rates.”

So they pivoted and when they pivoted, they moved really forcefully. They’re responding because the economy was giving them signals like, “hey, you got to course correct here.” That kind of response contributed to what has been—despite all that’s been thrown at the US economy since the pandemic—we’ve done pretty well here. That ability to change course and pivot is really important. That’s something that I think would be very hard if it’s all the political calculus behind it.

Krugman: Gosh. Actually having people in positions of responsibility who are willing to admit mistakes and change course, that’s a kind of an un-American idea at this point in our nation’s history. But an amazing thing.

Well, thanks so much. Quite an amazing moment. The Fed is not unique in this, kind of, fraught moment, but this is not some place I expected to see this kind of thing. Thanks again so much for talking to me.

Sahm: Thank you.