Talking With Adam Posen

A monetary policy maven about a Fed unde pressure

Adam Posen has seen and done it all. He was an important voice in macroeconomic debates in the 1990s, when he was one of the small group of Western economists who realized that Japan’s troubles were a warning sign for all of us. He’s been a policymaker, serving on the Bank of England’s Monetary Policy Committee, the equivalent of the Fed’s Federal Open Market Committee. Currently he’s president of the Peterson Institute for International Economics, one of the best if not the best economic policy think tanks in the world.

He’s also, I know from decades of acquaintance, open and articulate. So I thought it would be good to talk to him about the current craziness regarding the Fed, as well as the general economic situation. Transcript follows.

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TRANSCRIPT:
Paul Krugman in Conversation with Adam Posen

(recorded 7/17/25)

Paul Krugman: Hi everyone, Paul Krugman here again. This has been a crazy week in many respects, but luckily it's not my department and not my guest’s department to talk about Epstein and all of that. But a crazy week on monetary affairs. And I wanted to talk to somebody who both understands it and has real world policymaking, institutional experience. So I've got Adam Posen who runs the Peterson Institute for International Economics, one of the small but extremely important think tanks in Washington. He’s also a world class macroeconomist and one of the people who, along with me, got worried about Japan before it was fashionable, and he’s served on the Bank of England's Monetary Policy Committee, which is an equivalent of the Federal Open Market Committee in the United States. And so I thought Adam would be a really good person to talk about this very peculiar juncture we're in. So hi, Adam.

Adam Posen: Hi Paul, thanks so much for having me. I've been loving what you've done with the Substack, the interviews, the Martin Wolf conversations. So I'm really glad to be here.

Krugman: So before we get to firing Jerome Powell and all of that, what would be your assessment of where the U.S. economy is? And then we want to talk about what probably the Fed should be doing and then get on to the politics.

Posen: Well, in line with things you've been discussing, the uncertainty is big for forecasters. The uncertainty from Trumponomics, Trump trade, Trump firing, Trump corruption, affecting investment. I think growth is going to be highly dependent on two questions, I mean, since the labor market clearly is pretty resilient right now and balance sheets remain pretty strong, not like they were in 2023, but still by historical standards, quite strong for corporates and households. I think the main determinants are the balance of recession and inflation we get from the anti-migration work, or work is not the right word, the anti-migration barbarities and the anti-tariff, anti-global things. And I think they're both going to turn into stagflation with significant contraction and inflation from each. But there's room, especially on the tariff side, that it could be more contraction if real income is less inflation. And we'll have to see.

Krugman: My take, and tell me if you share this, is that if we didn't know that there were probably a lot of tariff and possibly deportation effects in the pipeline, you kind of look at the U.S. economy right now and say, “well, you know, it's kind of OK. Unemployment is OK, inflation is somewhat above target.” And when the economy is OK, there's not a compelling reason for the Fed to move either direction. Is that your take?

Posen: I completely agree. If anything, I’m a little more balanced than the consensus in terms of risk of inflation versus risk of recession, absent those things. But I also know, sure as shooting, there are real income shocks and a real supply shock to labor markets coming and potentially shortages of key inputs. And that has to show up somewhere.

Krugman: For listeners, “shock to labor markets” is basically that immigration has dried up and we're deporting people or putting them into concentration camps. And those are going to really hit production in some areas especially, which could be inflationary. And then on the other hand we have all this uncertainty which might be dragging the economy but none of that is really in the hard data yet, right?

Posen: No, absolutely not. And as I think you wrote in your recent Substack and Jared Bernstein wrote and I have been saying, it's not unreasonable that there's a lag for the tariff inflation effects to happen because people weren't sure the tariffs were going to stay and they had inventories of stuff they already paid for and they didn't want to be targets—“people” meaning companies, didn't want to be targets for raising prices.

But we're seeing a lot of signs in sort of Fed Beige Book terms, meaning anecdotal descriptions, very micro-level data, newspaper reports about tariff rises, glean rising prices. To me, it’s more surprising we haven't seen more of an effect on labor markets from the very anti-migration policies and the fact that we have essentially gone from what was averaging 2 million a year increase in the labor force to four million a year increase in the first couple of years after COVID to zero now. And that's a little surprising that hasn't shown up yet. But again, it's possible that people were waiting understandably to see how serious the Trump administration was gonna be in actually executing this.

Krugman: I have to say I worry in ways I didn't before about—clearly we're not yet at the stage of cooking the books—but I'm wondering whether the labor market data are fully able to pick up what's happening. Will a survey of enterprises capture a real drying up of day labor, or farm labor? We always look at non-farm pay growth. And yet, who's being kidnapped by ICE?

Posen: Well, I would make three points related to that. First is we already were having problems in the US and all advanced economies between IT and COVID and migration, not having quite as good dependable data collection. It's still worth doing. It's better than not doing, but we already were having reliability problems. Second, as I've been talking about with my colleagues, Jed Kolko, Karen Dine and David Wilcox at Peterson, and the Fed is starting to worry about, they are cutting back in various ways on funding of data. They don't seem to be cooking the books yet, but we are seeing the Bureau of Labor Statistics is collecting less data of various kinds because funding is being cut back. And there's real questions about how much data we're going to be able to keep getting.

The third point though, and my colleague, Jed Kolko, who was in the Biden administration Commerce Department has a point on this and others too, is that partly because of immigration, the break-even rate of new jobs we need every month to keep the economy going at a steady state is going down. Now, this goes against the thing you and I were just implying, which is there are specific industries in specific locations. Even more than agriculture, I would emphasize residential construction, single-family construction, where about 50% of the workforce, as far as we can tell, is migrant labor, a lot of it undocumented or day labor. So there are a bunch of things going on, but the data is not yet worrying in the hard sense.

Krugman: Yeah, I'm glad that you mentioned the Beige Book. You can tell me what the Bank of England does, if anything like this, but one of the really great things that the Fed does is in addition to all of the data stuff, it talks to people. It actually goes out and just talks to people out there in the business world and that can often be really informative.

Posen: Yeah, no, the Bank of England actually has a close analogy. They have something called ‘the agencies’ where they divided up the UK into, I don't know, a dozen or so districts. And they have someone or two people in each district whose job is to go talk to people and write up reports. So instead of having reserve banks staff, you have individual Bank of England staff. But the key point is, it illustrates exactly what you're saying. So Mervyn King, when he was governor, had an instance right before I got there where he and others on the committee became convinced that migration had jumped up a lot in the UK before it was showing up in the official data. They got it from the agency equivalent of the beige book and they were able to bet that the economy could expand faster for longer because they were right that the indicators were labor supply was expanding. And so it's a very apt example of how valuable this kind of structured anecdotal qualitative data collection matters.

Krugman: Okay, and so right now, that kind of qualitative stuff is setting off more on inflation alarm bells than the CPI is.

Posen: Yeah, absolutely. In the auto sector, just one more very relevant example. The manufacturer suggests a real retail price or whatever they call it for autos. This basically hasn't moved for cars sold in the US, partly because all the automakers don't want to get Trump's ire. But the actual price people are paying for cars is going up because they're all cutting back on financing gimmicks, incentives, they're cutting out the share of their cars in the lower price range that they're selling. So we're getting the kinds of rationing and price inflation in autos, even though on paper it hasn't happened yet. So that's an example of the kind of thing we're seeing.

Krugman: Okay, and so, sitting here right now, there's pretty good reason, actually there's extremely good reason to think that we're going to see inflation pick up in the next few months, eventually showing in the official numbers. What about recession or slowdown? What do you see on that?

Posen: Normally when I'm doing macro forecasting, and I think for most of us, you actually usually have more uncertainty around the inflation forecast near term than the growth forecast, barring something you can't predict like COVID or the financial crisis. This is the rare situation where I think it's the opposite. There's a wider range of growth outcomes for the U.S. possible than the range of inflation outcomes for the next year or two.

Krugman: Alright.

Posen: And this basically goes down to two things in my view. First is again, colleagues of mine at Peterson—Warwick McKibben, Marcus Nolan, Michael Clemens have all worked on this. According to mainstream models, the impact of the migration contraction, the deportations, but in economic terms, the net zero migration should be pretty big. There should be sectors, agriculture, residential construction, hospitality, food processing, certain kinds of mining, gardening, home health care, all of which should see material contractions and labor supply in ways that it's very hard to pay enough for legal residents, natives, to take those jobs. And at least there would be time involved in taking those jobs.

That doesn't add up to a huge share of the economy, but it adds up to enough that if you're seeing 10, 20% drops in production in those areas, that should be enough for a recession. On the other hand, the Fed and everybody seems to keep underestimating the resilience of the US labor market. This has been true the last few years. There is the possibility that AI for good and for bad is starting to kick in.

There was a transitional, I think, but important pro-productivity reallocation of labor after COVID. And then on the fiscal side, most people think the fiscal is going to be broadly neutral. This horrible One Big Beautiful Bill—and you've written about this, obviously—my view is it's going to be slightly more stimulative than people think because I think there's going to be more tax avoidance and the tariff revenues are going to fall off some. And I think the shift in incidence from higher to lower income people of some of the taxes is going to increase consumption. But anyway, we'll see.

Krugman: Again, for listeners, at least at a point in time, higher income people spent a much smaller share of their income than lower income people. Now, there may be some solution in there, but...

Posen: Yeah, but on the other hand, I thought we had data from Raj Chetty and his associates, and also I think from the JPMC Institute, that through COVID in the last few years, swings and higher income spending have actually been a bigger determinant of consumption outcomes, but maybe I'm just—

Krugman: No, it's possible. And one of the things is that if we're looking for historical precedents, it’s a situation where we don't know what the tariffs will be in two weeks, let alone further. There's really just nothing like this, I think.

Posen: No, not in 90 years, 100 years, and it's not comparable. I mean, the one thing you can say, and this goes to what people want to speculate about why the stock market hasn't crashed, is as you and Brad DeLong and others have been writing about, the possible profits for a lot of US companies and a lot of US investors that come from softer touch regulation, lesser enforcement of labor, environmental and other regulations, allowing encouraging mergers activity, energy deregulation, and then just potentially favoritism in a political sense for exemptions from tariffs and subsidy. You add all that up, potentially, even if it's bad for the economy as a whole, profitability could be rising. And so that's in our mix.

Krugman: I don't think I've written that, but yeah, that is a really good point. And we always say the stock market is not the economy. And we usually say that's because investors have the same information as the rest of us, but partly it's because profits are not the same thing as GDP.

Posen: Right. Exactly. Over long periods of time it has to be, but not in any given multi-year. And this I know you have written about, and that's what I was referring to, is the inequality work you and your colleague Branko Milanovichh and others have done about how the profit share of GDP varies over long periods of time.

Krugman: Okay, if you were on the Federal Open Market Committee as you once were on the MPC, I guess the next meeting is soon, right? What would you vote for?

Posen: I would vote for no change and I would, when appropriate, not trying to undercut the chair as some people seem to be doing, I would make public statements of nerdy sort you and I were just talking about, that the risks are balanced. The one thing I would differ from the majority of the committee and Chair Powell's recent statements on is this repeated statement, “we would be cutting if it wasn't for the tariffs.” I don't think that's right as a forecast and I don't think that's right politically. I think the tariffs are one reason to not be cutting, but for the reasons you and I said, I don't think there's an imminent need to cut even without the tariffs. And I think the risks from the migration and the fiscal are real. So that'd be my one difference. But in terms of voting, I'd be with the majority and the chair saying no, no change.

Krugman: This is probably going too deep into the weeds but I happen to like this subject. I'm normally a big monetary dove, though I actually agree with you. But I'd like to hear exactly what your reasoning is, and then I'll give you my version, I think, if necessary.

Posen: Well, when you and I first started interacting over Japan nearly 30 years ago, you and I were both monetary doves and I was an uber dove while I was on the committee in 2009, ‘10, ‘11. But I try to call them as I see them. And so right now you've got a pretty solid labor market, a contraction in labor supply and likely, on net, Unless AI is completely devil-lakes-macking up bailing them out, a contraction in trend productivity growth from all the terrible things that are going on. And I don't want to make a huge thing of it, but I do think there's a small amount that inflation expectations are less anchored now than they were before 2001, 2002. I don't think that should drive policy, but I think as a forecaster, I think you should recognize that any given inflation shock is more likely to accelerate, given the labor market, given the anchoring.

I also think, as we said, and this I'm less confident in, but pretty confident, that both the migration labor shock and the tariff shock will show up not entirely in real incomes, but they will show up in inflation. And then we've got the weird fact that tariffs did not lead to the dollar going up, tariffs led to the dollar going down. And as Morrie Obstfeld just argued and I and Marcus Brunnermeyer and Ellen Ray and a bunch of other people have said, this has to do with various other regime shifts, fiscal but primarily governance in the US. But anyway, you put all that together, that's a lot of reasons to think inflation is gonna be on the upside in my view.

And that even if you get a contraction, you won't necessarily get as much inflation offset from the contraction. And this is where I differ from Governor Chris Waller, if we take seriously his arguments, as opposed to the political stuff. A couple months ago, he was making a reasonable substantive case I disagreed with, but a reasonable substantive case essentially that the recessionary effects on inflation would be bigger than the inflationary effects, and that because the Fed was credible, it would be a one-off shock. And that's really the judgment call for the members of the FOMC is how much you think it's a one-off shock. That even if we get the inflation you and I are talking about, does it get passed around into more wages, more price hikes or something else.

Krugman: I'm going to intervene on behalf of the listeners again. The one-off shock thing is very much what we're all obsessed about. Presumably these tariffs will lead to a jump in the price level. 1.5%, 2%, something like that. But if that's the end of the story, then the Fed should sort of look through it, which they do when the price of oil fluctuates, for example. But we don't know that. It's a possibility, does it get built in? Does it get embedded into inflation? And again, we have no real historical baseline on which to...

Posen: Yeah, I would make two assertions. These are speculations that make me even a little less dovish. First is, I think it's fair to make a broad analogy to the early 80s in the following sense: that the Volcker Fed did a disinflation in ‘82. They didn't get inflation all the way down. They left it around four and a half percent. So when the next inflation shock came in ‘85—at least this is the received wisdom in central banking—that's part of why inflation went up more and Volcker had to really put the hammer down in terms of interest rates. And I think there's at least the potential, the risk, that because the Fed—for good and bad reasons, mostly good reasons—didn't drive inflation all the way back down to two, if we get another inflation shock, it goes back up.

You want to think about the salience, meaning how much attention people pay to various forms of price increases. Again, you've written about this and a lot of people have done recent academic work consistent with this, like Yuri Gorichenko, and my colleague Joe Gagnon. But how during the Biden inflation, people fixate on the price of eggs and they fixate on the price level jump. And even though inflation started coming down, that wasn't as salient to people. I think if, in line with our earlier discussion, you get sudden jumps in very visible things due to shortages of labor or supplies, like residential construction, like home health care, like fresh fruits and vegetables for agriculture, if these are very visible and large, I think the potential effect on people's expectations for inflation is larger than what their weight and this overall CPI would be.

So again, it's not for sure, but it just biases me to thinking there's more inflation risk in the current situation, a little more to worry about it not being a one-off.

Krugman: Okay, it's interesting. I’m not disagreeing at all, but I had an additional thing, which was, from 2002 to sometime last year we had this miraculous disinflation—the immaculate disinflation—and there were very good reasons to think that the inflation measures were actually overstating underlying inflation. And as that got worked through, there was a case for really being fairly aggressive on rate cuts because inflation was just disappearing of its own accord. And I don't see that in the data for this year, even before the tariffs effects hit, the miracle seems to be in the past. And that's a reason, again, not to be particularly a monetary dove.

Posen: I agree. And so, going back to where we started, if you're a fair-minded average Fed voter, you should be basically sitting on your hands and waiting. And you should be, if anything, emphasizing it's a two-way risk.

Krugman: Yeah. Okay. Now you mentioned Chris Waller, who's a Fed governor right now, and who has been right about some really big things.

Posen: Yeah, member of the board.

Krugman: There was the whole thing about the Beveridge Curve. Listeners, really don't want to know about this, but Larry Summers and Olivier Blanchard had a very alarmist thing about how underlying unemployment had risen, and Waller said, “no, I don't believe it.” And Waller was right. He's got some big wins under his belt, and he is a dove. He wants to cut rates further. Presumably because of that, he's among the names that people are floating as a possible Trump pick for Fed chair. Now I think there's absolutely no chance that he would get that job. The problem is that Waller is actually a serious, good analyst and principled, all of which are disqualifying for these guys.

Posen: Right.

Krugman: First question: Trump’s view is not just that the Fed should cut at its next meeting, but the interest rates are three percent points too high. Now, what do you understand about that reasoning, such as it is, and what's your view on that general? I know you don't support it, but can you offer anything like a good faith rationale?

Posen: Now, there are a number of things for the Trump policies that don't actually justify them, but the parts of the package where you could offer a good faith rationale of sorts, are not the migration policy and not this. So, there is 300 basis points. Three full percent is the kind of cut you do when it's 2008 and the world is coming to an end and you're trying to stabilize the world from coming apart.

It basically requires not just a recession, but a belief of deep financial fragility in the system to justify that kind of change in monetary policy from anything that looks close to right. And to do so quickly, it needs that financial fragility or COVID or something like that that is a huge negative shocker vulnerability. So there's just no justification for this on that basis.

The other thing, as Maurice Obstfeld, our mutual colleague and friend has pointed out, is of all the package of Trump economic policies and one big bill and tariffs and the rest of it, the macro side having to do with the dollar and interest rates is the part they seem to most self-contradict on. You can come up with some crazy story for why the tariffs make sense, but then they do things that would presumably raise their interest rates, lower the dollar. And this is a key point. I mentioned Hélène Rey who's a professor at London Business School, one of the top international finance economists in the world right now. And she did a very nice recent paper that established with robust econometrics, which a lot of us have pointed out using simple charts, that the dollar was going along normally the way it would with interest differentials; meaning, are you getting more interest in the US or in euro area or with how high the 10 year treasury rate is? And the correlation was very high and it was stable. And when there were problems, the dollar would go up and interest rates would come down. Because even if the US caused problems, even money would flow into the dollar.

And what we've seen since April 2nd is a complete reversal of this correlation. So, I looked at the correlations yesterday before my coming on this podcast. And the correlation between dollar index and 10-year treasury, and I'm sure you'll have to translate this, but anyway, was 0.8 positive. So they just ran together at least since 2014. As of April 2, and this is daily data, the correlation goes from plus 0.8 to minus 0.45.

Krugman: Okay, so this is probably where I do a little translation. It used to be and has been true for a very long time, that when interest rates were high in the United States, particularly when they were high relative to other advanced countries, the dollar went up. You made more money putting your money into dollars and that would drive up the dollar and it was pretty robust, it was pretty solid. (I'll choke a little bit on that.) But anyway, since Liberation Day, that's gone into reverse, that we see higher U.S. interest rates associated with a weaker dollar, which is something that you don't see. You don't see that in any advanced country, as far as I know.

Posen: You see it occasionally in the UK and if you include the data from the euro crisis, you see it in some European countries. But for a long period, this is Rey's work, the dollar, Swiss franc, Japanese yen, and a couple others did not display this for decades at a time. And now we're seeing it. And it's a warning sign that when push comes to shove, people are much more nervous about the dollar, meaning official investors, private investors, et cetera. And so that goes to your point about this 300 basis points. If in addition to everything else, the Trump gas is cutting interest rates hugely, when it's not appropriate, thereby you both undermine trust that the Fed's independent and is making up its mind on a good basis, and you just did a crazy policy, you're making the dollar particularly unattractive. We could see a huge movement down in the dollar.

Krugman: For complicated reasons, I've been doing a lot of talking to Brazilians lately and basically saying, “hey, we kind of look like you these days.” Not on the same magnitude, it would kind of correlate directionally. It's interesting because if you were going to make a case for what would normally be considered an emergency interest rate cut, you would have to say that the US economy is or is about to be in dire straits.

Posen: About to be in dire straits and monetary policy would have to be way behind the curve.

Krugman: Well, Trump does always call Powell “too late Powell.”

Posen: Yeah, but he's wrong.

Krugman: Well, there's the argument they waited way too long to react to inflation. But the question is, what's too late to react to now?

Posen: So, a year and a half ago, first quarter of 2024, there emerged a consensus on the FOMC, including from some people I respect deeply, that the Fed had to start cutting, they were worried about labor markets. And I and some others said, “we don't think that's right. You're overreacting.” And over the past year and a half they've moved away from that and now they've moved back. The Fed's record, the senior staff record, the forecasting record on labor markets isn't great, to be honest. But there's a big difference between getting a short-term forecast issue wrong and resolutely doing something for political reasons that is, like you said Paul, an obvious cause without an obvious economic cause.

Krugman: In terms of getting things wrong, I think the magic three words are compared to what? Compared to who?

Posen: Right. And how consistently do you get it wrong in the same direction every time? Or do you get it wrong sometimes one way, sometimes another way?

Krugman: Yeah, and you can always find somebody who got it right when the Fed got it wrong, but you just look into it and it turns out that guy has gotten 10 other things completely wrong. There's a real puzzle here, right? We did have a large rise in interest rates, which if you'd asked me beforehand, I would have said that would lead to a sharp slowdown in the US economy. And so this mysterious resilience.

Posen: Sure. Yeah, and that is something that is not yet figured out. I think there's three possible causes that I would think are important. One is, and this relates to Chris Waller’s stuff, but also some things that others have written.

You know, I'm a little younger than you, but when you and I were coming up in grad school, a lot of the talk was about costless disinflations. There was this famous Tom Sargent book about ending hyperinflations, the Brazil example. The idea was, if you had a really credible central bank, people would adjust quickly and then the costs of disinflation wouldn't be that high. And like you said, Blanchard and Summers based on very reasonable mainstream thinking thought the costs were going to be high. And so part of it is maybe that after 40 years of low inflation, the Fed was able just to add more credibility. I think that's a part of it. I think the other two things that are going on, or went on, is first, I think there's been a recurrent debate over how much you treat the Fed funds rate or the real Fed funds rate minus inflation as a sufficient statistic as a summary or indicator of the actual monetary conditions, the amount of looseness or tightness in the country, in the economy.

Krugman: By the way, the Fed funds rate is the interest rate on money that banks lend to each other overnight. And that is literally the rate that the Fed can control. It presumably percolates at least some ways down towards interest rates that actually matter to somebody.

Posen: Yeah, and famously, Jeremy Stein, when he was on the Board of Governors, gave a speech during the financial crisis in which he said, “the great thing about interest rates is it gets in all the cracks that it permeates out.” And I'm not a brilliant academic like Stein, but I've always felt the financial crisis showed us the exact opposite, that there's a lot of barriers and imperfect markets and financial markets.

So, yes. The Fed raised interest rates 5.5%, which normally would be enough to send the economy into a huge halt. But when you looked at, say, the risk spreads between what government bonds were paying in interest rates versus junk bonds of riskier companies, when you looked at the availability of credit on various measures, these didn't move much at all. And so I always felt the amount of actual tightening in the Fed's economy in this case was lower than we thought.

Also just one last point, a little self promotion. Asher Rose (who's a research analyst at the Peterson Institute) and I have a forthcoming paper talking about this one off labor market shift in the US as a result of COVID, which actually seems to have increased productivity at least for a few years. And that overlaps with this period of disinflation. So I think that also was a contributor to the lower cost disinflation.

Krugman: Okay, I'm going to add one thing. For my sins, I actually do read Truth Social posts on all this stuff. Trump seems to view interest rate cuts as kind of like a dessert or a reward. We've got a great economy and it deserves lower interest rates. That's the only way I can make sense of what he said.

Posen: Yeah, I mean, in a distorted way, it's one third true, two thirds false. So the distorted way in which it's one third true is if we have an economy that has a good productivity growth rate, a good labor force growth rate, and is relatively flexible, and we can debate about how much deregulation of what kind, but relative to other countries is flexible, we should be able to sustain lower rates, more growth at any given time.

But the two thirds that it's wrong is: it's not a question, it's more like a thermostat. It's not like you put on the air conditioning as a reward. You put on the air conditioning and the heat depending what the season is and your goal is to keep it at a reasonable temperature. And so the analogy is just false. And so even if we deserve climate control and in some sense can pay for the gas bill to do the climate control, you don't turn on the AC in the middle of winter.

Krugman: Okay. That's actually a better analogy than ones I've been using. I'll steal it.

So, it varies day to day, but clearly Trump is waving around a piece of paper that may or may not have been a letter trying to fire Powell. It's not clear that he has the ability to do that, but on the other hand, it’s never clear at all what the Supreme Court will decide is actually within Trump's legal rights. But what do you think would happen if Trump really does force out Powell? I mean, there are questions about what happens at the Fed, because the Fed is not a dictatorship, and also what happens to expectations, the markets. What's your take?

Posen: Right. To sound really nerdy, I actually did my dissertation on central bank independence a long time ago. No reason for you to know that. And also did some subsequent work on this with Kenneth Kuttner of Williams College. And anyway, so let me distill down the knowledge we and others have on central bank independence into a couple things. The first is what everybody says. If you look across national data, countries with lower central bank independence on average have higher inflation rates. Then that gets conflated with a lot of things. The inflation came down all around the world and also central bank independence went up all around the world so you can't do it. But that's based on things like Brazil in the past, Italy in the past and so on.

A deeper look, which Kuttner and I did and some others have done related and reproduced, is that there's really two key components to what makes central bank independence matter. There are two components that actually matter for inflation. The first is, can the central bank be forced to buy government debt directly? The famous example of this was back in, I think, the late 70s, maybe it was early 80s, I apologize. There was the so-called divorce of the Banca d'Italia from the finance ministry that they were no longer forced to buy Italian debt. Or the 1950s end of the Treasury-Fed accord. And that's basically a yes no. If the central bank outside of, say, wartime can be forced to directly buy government debt, you're going to get inflation.

The second thing is scarily, do you try to fire the central bank governor? And it turns out Alex Cukierman first pointed this out and then I subsequently did more on this. It turns out, and like you were saying about exchange rates and other fiscal cases like Brazil, this used to be something in emerging markets. So if you were firing the central bank governor rather than letting her or him serve out their term, like Erdogan tried to do, like Modi did a couple of times in India, then you get jumps in inflation. So that already sets you up to say, if Trump is motivated to push down interest rates, even if he's not literally selling bonds directly to the Fed to print money to pay for the fiscal deficits, it's in the wrong direction. And if he's threatening about firing or actually fires Powell, there's hard evidence that that leads to a jump in inflation expectations, a reduction in the central bank.

Krugman: Alright.

Posen: One final point. So Kuttner and I published a paper in 2007, called Do Markets Care Who Chairs the Central Bank? And we put together a data set of changes in central bank governors. And it turns out that new central bank governors are not inherently suspected. This is about how markets react. People in the markets don't automatically assume because it's a newbie, we have to test them, we're not sure. What they do seem to do is try to assess, essentially, is the person coming in hot? And we also showed that changes in US central bank governor, or chair of the Fed, had much bigger average effects than any other central bank, which you would expect. And so again, this suggests that if the Fed has an appointment from Trump that is clearly meant to be more dovish, that will have a big impact on markets.

I do agree with some of the people who are saying, it actually doesn't matter that much which of the three or four individuals they're talking about as potential Fed chairs, because it's the incentives and the pressure from Trump and the effect of that. Probably Waller is a better outcome, but beyond that, I wouldn't. The committee votes and they don't if there's obvious inflation, they might be a couple months behind reacting if you have a compromise chair, but it's not fundamentally going to do it.

What I do worry about a lot, which I haven't been seeing people say, is that the Board of Governors actually controls a lot of things to do with financial stability with bank mergers, with bank supervision, with rules about who gets access to bailouts and the discount window, with rules about crypto, which you've been rightly warning against. And that of course is more directly linked to some of the profits of people associated with the Trump administration. And so I'm actually less worried about a compromised independence on the inflation front, even though I think it'll be bad and it'll raise the interest rate premium, the average interest rate charged on US government debt, which is not helpful. But I really am worried that if you got a Trump chair of the board and additional Trump appointees on the board, they could lead to financial stability risks through crypto, through irresponsible bank mergers, through lax supervision.

Krugman: Yeah, that's interesting. I really do think Waller is in a very different category from the others. I don't think it matters which of the Kevins we get. It doesn't matter as long as it's going to be that kind of guy. Doesn't matter whether it's Kevin Hassett or Kevin Warsh or the MyPillow guy. It's going be the same in terms of monetary policy. But regulatory stuff might be the same thing.

Posen: Yeah, I agree. I think there's more room for play and there's less of a counterweight from the rest of the FOMC because it would be just the Board of Governors and, depending how things go, the President could appoint a majority of the Board of Governors pretty quickly whereas he's not going to be able to turn over the FOMC. Additionally, I may not like this, but it is entirely fair and legal and reasonable for the new president to make Bauman vice chair of supervision at the Fed. I didn't like how they did it but, you know, he's entitled to decide that he wants bank merger policy to be different. But there's so much discretionary, not very visible stuff on specific banks and institutions that the board gets involved in. That could be hidden. Again, I might argue against it, but it is not a usurpation of anybody's power or overtly irresponsible. So that's also part of why I'm more worried about the financial stability side than the inflation monetary policy side.

Krugman: That's a very interesting take because I've been guilty too. I've been focusing on a Turkey-type story on inflation...

Posen: Yeah, I think it's there, but it's not…

Krugman: The whole thing with central bank independence is precisely because you worry that you might have elected officials kind of like Trump, although I don't think anybody quite imagined on this scale.

Posen: One thing that some people are saying, and I don't know the data well enough to argue this, but strikes me as plausible, is this is being more expressed in the currency markets than in the treasury markets, because it's just cheaper and easier to do that than to be messing with your treasury holdings.

But honestly, I don't know. I think just frankly, sometimes markets get it wrong. The fixed income bond market tends to get it wrong less frequently in the sense of the whole economic outlook than the equity market. But as you wrote about with bond vigilantes, fake storms for years, sometimes bond markets get it wrong. And that's where smart hedge funds and others make their money. So I don't have a good explanation, but I just think they're getting it wrong.

Krugman: Yeah, it's funny because normally you'd say, there's so much money riding on it. But on the other hand, the economists at major investment banks are generally smart people, but they fundamentally have no access to anything, no information that you and I don't have as well.

Posen: No. And I mean, going to what you just said about how no one envisioned Trump, Trump economics, Trumponomics, whatever you want to call the package. If you separate it from the human side or the value side, just the economics package is to my mind causing huge amounts of cognitive dissonance among a lot of people who say, “well, some of it's just tactics.”

Or “some of it's for show.” Or, “yeah, he's going a little too far, but something will rein him in.” All these different versions of, “Well, there's this stuff we like, which is ostensibly cutting the deficits, deregulating in a positive way, rebalancing, even though I don't really know what that means, but rebalancing to get more paid for from US defense policy, from foreigners, more exports…”

There's a bunch of sort of wishful thinking, inertial thinking that this is all somehow part of a sort of normal shift and, on balance, is positive. And again, I think we're under a genuine regime change. I argued for this after the election and a piece I did in Foreign Affairs. And I think people are just reluctant to price that in. It's understandable cognitive dissonance. They don't want to believe it. But I think that's what's going on in part.

Krugman: So, things are really scary, but people don't want to see it. There are quite a few horror movies like that. It’s not usually what we think of when we talk about monetary policy, but lots of stuff that was dry and boring is now terrifying. So it's probably a good place to bring it to an end. Thanks so much for talking to me.

Posen: Thank you for having me, Paul, and keep doing what you do in the public discussion. It's great.