Alan S. Blinder teaching in 1983. (Princeton University, Robert Matthews)

On Money, Inflation, and the Current Banking Crisis

Interview by Donald H. Sanborn III

Alan S. Blinder is the Gordon S. Rentschler Memorial Professor of Economics and Public Affairs at Princeton University, and a regular columnist for the Wall Street Journal. Blinder served as vice chairman of the Board of Governors of the Federal Reserve System from June 1994 until January 1996. Before becoming a member of the board, Blinder served as a member of President Clinton’s original Council of Economic Advisers from January 1993 until June 1994. During presidential campaigns, he was an economic adviser to Bill Clinton, Al Gore, and Hillary Clinton.

Blinder has written scores of scholarly articles, and is the author or co-author of 23 books, including the prize-winning best-seller, After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead (2013) and Advice and Dissent: Why America Suffers When Economics and Politics Collide (2018). His latest book, A Monetary and Fiscal History of the United States, 1961-2021 was published in October 2022 (Princeton University Press). Blinder earned his AB at Princeton University, M.Sc. at London School of Economics, and Ph.D. at Massachusetts Institute of Technology — all in economics.

Here, he discusses his latest book, as well as inflation and the current U.S. banking crisis.

In your introduction to A Monetary and Fiscal History of the United States, 1961–2021, you ask rhetorically, “How does the past shape today’s attitudes, options, and debates over monetary and fiscal policy? What worked and what didn’t — and why?” How would you answer these questions, or guide the reader toward possible answers?

I try to guide the reader, in the book — it’s chronological — through historical episodes, both of fiscal and monetary policy, including times when they were at loggerheads — sometimes literally fighting, at times when they were cooperating, pulling in the same direction. And then, at times when only one of the two arms of stabilization policy was operating — and the other was either asleep or paralyzed. There are examples of every one of those sorts of episodes in the 60-year history covered by the book — which runs up to 2021, leaving us a little bit short of the Federal Reserve’s tightening of monetary policy that started in 2022.

You specify the time frame in the title. How did you choose that period?

I started there for three reasons. One is my age; I was a teenager in 1961 (and pretty soon an undergraduate at Princeton — when the Kennedy-Johnson tax cut passed).

A more interesting reason is that the Kennedy-Johnson tax cut was the first instance of deliberate, as opposed to accidental, use of fiscal policy to move the economy, in this case to make it grow faster with a tax cut. We hadn’t done that before in America. Other countries were ahead of us in that respect. But it was a new idea in policy circles here; it was called the “new economics.”

The third reason, which is germane to the title of the book, is that Milton Friedman and Anna J. Schwartz’s epic A Monetary History of the United States, 1867-1960 ended in 1960. I wanted to pick up the story there, and didn’t have any wish to overlap with their story.

You note that the phrase “Those who cannot remember the past are condemned to repeat it” is a cliché, but one that is often too true. What repeating patterns appeared to you as you researched the book?

Monetary and fiscal policy is sometimes well-tuned to the current circumstances (the dosage is roughly right) but sometimes it isn’t—and we see episodes of this in the history, where you get too much stimulus, or too much contraction, or the two arms of stabilization policy are fighting each other, which is not normally a good idea.

We learn about lags in monetary policy, which is germane today, and the danger that poses — that either a monetary tightening or a monetary easing (these days it’s a monetary tightening) could go on too long, because policymakers forget to account for the lags properly, and they put tightening in the pipeline, but the effects haven’t shown up yet, so they keep on tightening.

We learn that there are cases — the recent circumstance is not such a case, where monetary or fiscal policy both pushed in the wrong direction. Maybe most importantly, from the point of view of an academic, we learn of instances in which fads and fancies — I don’t even want to call them “theories,” although they pose as theories — sometimes grip policymakers, leading to grievous errors, both on the fiscal and monetary sides.

So, I talk about monetarism, rational expectations, and supply-side economics as examples — doctrines that may or may not have had intellectual foundations, but if and where they did, were not applied very well in the policy arena.

Of the events you cover in the book, what aligns most closely to our current financial situation (the banking crisis)?

The savings and loan crisis in the 1980s. (It actually has roots late in the 1970s.) I don’t spend much time on that, actually, in the book, but that is the closest parallel. What happened then is the Federal Reserve raised interest rates sharply to fight inflation — as has happened recently — and a bunch of financial institutions (in those days it was thrift institutions, savings and loan associations; more recently it’s been banks like Silicon Valley Bank) had an unbalanced book in terms of interest rate risk.  Concretely, they had assets that went down in value when interest rates rose, and the rates they had to pay to their depositors rose with market interest rates.

“The Tree Swing” collage made from deconstructed U.S. currency. Artwork by Mark Wagner. (Markwagnerinc.com)

On April 12 CNBC reports that inflation rose just 0.1 percent in March and 5 percent from a year ago as “Fed rate hikes take hold.” What is your reaction to this news, and what should happen from here?

I think it’s a little bit of good news, but I’m not sure how much of it to attribute to Fed rate hikes. One thing we learn from history, and from statistical studies (econometric studies of the economy) is that monetary policy works with very long lags. The Fed’s only been tightening for about a year. So, it’s still a little early to be expecting major effects, of the Fed’s tightening, on inflation.

The other place where there are clear and sharp historical parallels is between the recent situation — by “recent” I mean going back to the pandemic and the war on Ukraine, right up to the current moment — compared to the 1970s and 1980s, when the dominant influences on inflation were supply shocks. Oil and food jumped in price, causing a lot of inflation quickly, while so-called core inflation — excluding food and energy — moved up also, but much less.

A similar script was followed in the recent inflation. If you ask how the inflation rate in the United States briefly got up to 10 or 11 percent, it was not mainly because of an overheated economy from too much fiscal or monetary stimulus — those were minor contributors. The main reasons were that energy prices started soaring, even before the war in Ukraine (and then they soared more after it); and food prices started soaring after the war in Ukraine started. On top of that, because of the aftermath of the pandemic, we had all these supply bottlenecks all over the place — in many industries, in many different places. That was something new, that really did not have an historical parallel — at least not in the period of time that I’m talking about. I think you have to go back to the demobilization from World War II to find parallels to that aspect.

In any case, you have these adverse supply events. While it was a new thought in the 1970s, and people like me — who were trying to persuade people that you should look at core inflation, which excludes food and energy, as well as headline inflation, which includes food and energy — had a bit of a struggle. I remember people saying, “Don’t people pay for food and energy?” Of course they do, but if you’re thinking about monetary policy, what in the world can the Federal Reserve do about food and energy prices? The answer is: next to nothing.

They can do things about the rest. That was a new, and not fully accepted, story in the 1970s and 1980s. By now, it’s not new, and it’s pretty much accepted. For a long while, headline inflation was behaving much worse than core inflation. Just recently, that has reversed; we now have core inflation a little bit higher than headline inflation, which has not been the case for most of the last two years.

In February, you wrote in the Wall Street Journal that inflation had fallen to a sufficient extent that the Federal Open Market Committee (FOMC) should debate pausing rate hikes. Would you write the same piece now?

Sort of. I do think the Federal Reserve should be thinking seriously about pausing their interest rate increases, but it’s not for the reason that I wrote about in February. [Now] it’s mostly because of what has happened recently to the banking system — Silicon Valley Bank, Signature Bank — and concerns about two things: First, further contagion to the rest of the banking system; knock on wood, that’s looking pretty good right now. And second, diminution in bank lending as a result of these travails — that is not looking very good right now; the recent numbers on bank lending are suggesting contraction, and that’s going to take a bite out of economic growth.

The Federal Reserve has been raising interest rates, trying to slow down economic growth, as a way station to slowing down inflation. Now the Fed is getting some of that slowing down from the banking crisis (if you want to call it a crisis). That seems to me a good reason to pause. The banking crisis may not prove to be a real crisis — more a molehill than a mountain — in which case the Fed probably wants to go back to raising interest rates further, to fight inflation. But we don’t know that right now, so that’s why I think they should pause.

If you were still the vice chairman of the Board of Governors of the Federal Reserve System, what course(s) of action would you be advising, and what needs to happen to avoid or minimize a similar banking crisis in the future?

I’d be urging the FOMC to pause its interest rate hikes, until the dust settles. Secondly, I would be urging — and I think the Fed or the Congress will do this — to backtrack on the regulatory easing that Congress did in 2018. Famously, the line for extra scrutiny and tighter regulation of banks was drawn at $50 billion in the Dodd-Frank Act of 2010, but, then raised to $250 billion in 2018.

I think $50 billion was too low, and that was a mistake. But raising it to $250 billion was too high. Silicon Valley Bank was under the $250 billion threshold (they were at $215 or $220 billion in assets) — and therefore were not subject to the extra scrutiny and tighter regulation of large, systemically important banks. I think that was an error that will be corrected, and should be corrected.

(Courtesy of Princeton University Press)

(Courtesy of Princeton University Press)

What do you most want readers to know about your book, A Monetary and Fiscal History of the United States, 1961-2021, and/or current financial news?

I quote this in the book: Mark Twain famously said, “History doesn’t repeat itself, but it often rhymes.” You want to learn the rhymes, because there is rhyming in history.

We’re going through that right now. You asked me what was the closest parallel [to the present]; and there are several historical parallels. We should learn from what policymakers did right, and what policymakers did wrong, in those parallel — but not identical — circumstances. And then, to really get it right, we need to adjust for the particularities of what we’re living through now.

The Silicon Valley mess is not the same as the savings and loan crisis. The inflation problem faced by Jerome H. Powell and the Fed is not the same as the inflation problem faced by Paul Volcker and the Fed in the early 1980s. The supply shocks buffeting the economy in those two periods are not exactly the same, and you need to adjust policy for that. But there are similarities. It rhymes.