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This is exactly where we like to see central bank independence, because central bank independence is thinking about manitre palsy.

Not for the next eighteen months, but for the next few years.

I'm Stephanie Flanders, head of Government and Economics at Bloomberg, and this is a bonus episode of Trumponomics, the podcast that looks at the economic world of Donald Trump.

While I was in New York this week, I hosted a fireside chat with Bill Dudley about the future of the Federal Reserve and its monetary policy.

Bill was once President of the Federal Reserve Bank of New York.

Before that, he was a chief economist at Goldman Sachs, among other things, and he's now a columnist for Bloomberg Opinion and a senior advisor to Bloomberg Economics.

In our conversation, we discussed not only the political threats to fail independence growing by the day under President Trump's administration, but also the US Central Bank's monetary policy right now and the implications of tariffs and the AI investment boom.

I started the conversation by asking Bill why he thinks it would be a bad idea for the FED to keep cutting interest rates over the next year or so, which is what the future markets are currently predicting.

Well, I think there's a debate going on between what's the biggest risk inflation staying sticky above the two percent target for if we go through next year the fifth year in a row, or the layer market to continue to deteriorate and potentially giving away and having a recession, and Pouls trying to navigate between those two risks, and as he said, it's very difficult to figure out what to do in the current environment.

Where he lands is that he thinks that the greater risk, or the increasing risk at least, is the downs side risk to the labor market, and as a consequence of that, he wants to make manentre policy less restrictive to sort of reduce that downside risk to the labor market.

Now, I think you could make the argument that the upside risk to inflation still is very much germane because the pass through of teriff of terrorists into prices is probably quite incomplete, and we have a number of other exogenous factors that are going to also put upward pressure on inflation.

For example, what's happening with the AI investment boom and the consequence of that for electric prices.

Now, I know we like to historically exclude food and energy from our calculation of inflation, and that's fine when the prices go up and the prices come right back down, but that's not going to happen for electricity.

The prices are going to keep going up for the next few years, and so I think that have to be considered a part of the inflation outlook.

I think where I come out is a little differently than Paul.

I think that the inflation risks are just as substantives as the downside risk labor market number one and number two.

I don't think policy is as restrictive as he thinks it is.

He thinks that policy is restrictive, so they're say before he wants to make it less restrictive.

I think if you look at the economy writ large, it doesn't look like Madre policies holding back the economy hardly at all at this point.

You know, if you look at the Atlanta Fed GDP now forecast for the third quarter, it's tracking three point eight percent.

If you think about the exogenous AI investment spending boom that's going to continue to support economic growth as we go through the rest of twenty twenty five into twenty twenty six.

So that's the first point of sort of mild disagreement.

The second point is, I just feel like the risk of inflation expectations rising is just as substantive as the labor market continue to DETERIAD.

What Paul's worried.

About in the labor market is that when the labor market det rate's beyond a certain point, it tends to be self reinforcing.

And this is really summarized in the sum rule.

Every time the unemploying rate's gone up by half a percent, the US is all into reception, with one important exception twenty twenty four.

Twenty twenty four, we had a mild trigger of this somrale.

Nothing bad happened.

But I think that notion that labor marketed touring beyond a certain point is still valid because what happened in twenty twenty four was the unemploying rate went up not because of labor market weakness, but because of a big surge and labor supply.

This year, if the unemploying rate goes up by half a percentage point, it's going to because of weakness and labor demand.

What concerns me on the inflation side is, you know, we were sort of pushing the envelope here of how long inflation can be above the Fed's target and inflation expectations state will anchored.

At some point people are going to start to believe that the FED doesn't really care about getting inflation back to two percent to three percent is good enough.

And if that happens, then inflation expectations will become a bit less firmly anchored, and that'll be harder to get inflation down in the future.

So my own personal view is I'd be a little bit more patient.

Also, I think, you know, they's just a tremands amount unsurty in terms of that can We've never had a you know, a TERRFF shock like this.

We've never had an AI investment spending boom like this before.

We've never had such a dramatic change in labor supply before.

So there's a whole bunch of you know, wild cards that I think, in my mind make me less confident in my forecast.

And if I'm less confident in my forecasts, going to be sort of like you don't want to take the Democratic oath of do no harm.

That's fantastically useful to run through all those Let's just pick up there.

There's a couple of things from there about what constitutes restricted but also about the pass through the of the tariffs.

You know, there is just a lot of uncertainty, and so far things have not necessarily played out certainly the way we might have expected from the models.

It's a puzzle, frankly on all sides of the newsroom in Bloomberg as well, because we're talking to people in senior business figures who appear to be kind of nervous of mentioning tariffs in their earnings calls.

If it's not being shown in prices, these tariffs, which are definitely being paid at the board, you'd expect it to be shown in earnings, but we're not seeing an obvious effect there.

Our own Anna Wong has suggested that even just the sheer uncertainty attached to the tariffs this time around, the fact that they're jumping around so much, has actually stayed manufacturers, how retailers hand in changing prices because they think, oh, well, he may there may be a tweet next week and he may suspend it for another few months.

So just on that, what's your sort of solution to the puzzle of how tariffs are or are not actually being shown in the economy and prices particularly, Well.

First of all, I think the path through process just takes a little bit longer than we expect because the goods have to move from abroad to the US, they have to be unloaded, shift to the retailer, and the retailer actually has to sell the goods at the higher price, and that takes a number of months.

Number two, to your point, the encertainty level is really high.

And I think when a certainty is really high and there's a cost of raising prices in terms of your customer relations, you want to get more certainty before you decide how big a price rise that you want to put into place.

So it's better to raise the prices once and rather than raise the prices multiple times.

So I fully expect that you know, most of the tariff burden is ultimately going to be passed through, you know, probably on the order of eighty percent, and I think that's probably going to be worth you know, one to one percent to one and a half percent on the level of prices.

So I'm pretty confident that inflation is going to be three percent or more, you know, well in well through the first half of twenty twenty six.

So I think it's I think it's more delayed than not coming, because to your point, if it's not showing up in earnings, then we're going to be seeing it at some point.

And on the question of whether it's restricted, obviously, one of the arguments that's been used by Stephen Myron and others for why it is actually more restrictive than we think the policy currently is that the natural rate has fallen for reasons that he described in his testimony.

I think that the house view is certainly that that's not the case.

But is that one of the things that you're thinking about in looking at considering where the policy is restrictive enough?

As cher Paaloa says, we know our star by its works, and what he means by that is we look outside see how the commedy is performing.

If the comedy is stronger than we thought, then we tend to revise up our estimate of our star.

And if the e commedy is weaker than we thought, we tend to revise down our estimate of our store.

I'd say, right now, given all the uncertainty in policy, the tariff shock, you know, it is a tightening of physical policy.

Given all that, you'd have to say, the commedy is performing better than expected.

In fact, you know, it's the last FED meeting, the FED revised up their growth forecast for twenty twenty six by a couple tenths of a percent.

So that to me tells me that our star is probably a little bit higher than we think now.

You know, Stephen Moran made a number of arguments why our star is lowered, and I think some of the arguments are actually sensible, but some of them are not.

And of course he conveniently, I think, ignored some of the factors that are also resulting in a higher our star.

The investment spending boom, for it was just totally not even mentioned by Marian in his remarks.

And it's hard to believe that the investment spending boom in the short term doesn't increase the demand for capital and result in a higher interest rate to consistent with a neutral manetary policy.

You know what.

The argument where I agree with him is on the slower growth of the population, slower growth of liver force, that one, I think is you know, a good argument because I think if you have less people, you need less capital to equip them to work.

So I think that one was something I agree with.

But the some of the other arguments I think are btr cherry picking the arguments to support his point of view.

But the biggest problem is how does he explain if.

The policy is as restrictive as he says it is, then why is the economy performing so well?

There is this kind of mystic meg aspect to the our Star debate.

You have this feeling of you never can see it, never can put it down, But we talk about it a lot.

We're going to talk about it more later.

Finally, just on the short term situation, given that you have been, unlike most of the people in the room round the table for these discussions, how will the FMC be thinking about the shutdown?

And how important is it the timing If the government goes back to work, say this week or that it's seeming pretty unlikely, what kind of difference does that make relative to it being what seems likely to be a pretty prolonged shutdown.

So historically these government shutdowns have not had a big effect on the economic trajectory.

And the reason for that is people.

Ultimately get paid even for their or even for the time that they were furloughed, so that they don't actually adjust their spending habits in any significant way.

But this shutdown could be a little bit different because there are people that apparently are going to be furloughed, there are people who are not getting paid, so it might have a more damaging consequence to the economy.

Now, I think everybody's of the view that this is not going to last sort of indefinitely.

You know, maybe it goes a month, maybe it goes five weeks, but I don't think anyone is expecting it to last through the end of the year.

And so at the end of the day, the size of the shock that this is going to generate to the economy is pretty small, and I would think that it's unlikely that it's going to have a real big consequence for MONTARC policy.

Now the October meeting, I think the FED is definitely going to ease at this point.

Once you started to ease, you're almost going to certainly go in the same direction unless you get a new set of information that contradicts your motivation for easing in the first place.

Since the FED is getting virtually no information, of course they're going to keep going in the same direction.

There's a yeah, of course, that's a good point in terms of the BLS numbers and other things.

Okay, So, I mean, one thing that I like about your columns that you do for Bloomberg Bill, and certainly why they get read, is that you have these admirably direct headlines that say basically what you're going to say.

And if you'll forgive me fourth of August column, the FED is under siege and it'll be just fine.

That was one column.

Yeah, I changed my mind on that one three weeks later.

Three weeks later, just about the time that Lisa Cook was attempted to be fired.

I wasn't very worried about the FED now I am.

So if you are, why isn't Wall Street.

That's a good question.

I don't have a good answer for that.

I guess Wall Street is just very uncertain how this all is going to play out.

Obviously, the Lisa Cook case is going up to the Supreme Court, and how they rule is going to be really important.

If they rule that President Trump can dismiss Lisa Cook for cause then in principle, President Trump can dismiss other members of the Board of Governors for cause, and it's not even clearer whether what his authority would be over the Federals or bank prisons.

The fear in markets is that the Trump administration will soon get could soon get control of the Board of Governors, and then those that majority on the Board of Governors could then start to decide not to reappoint Federals or bank presidence when they're five year two terms come due in February of next year.

So you can see that how you can bootstrap control of the Board of Governors to having control full of the broad Federal Open Market Committee, even if the Lisa Cook case has decided in favor of the president.

I don't think this is preordained.

We don't really know what, you know, Chris Waller and Michelle Bowman would do.

I thought it was interesting at the last meeting that they went along with the majority for a twenty five base point raycut, not the fifty bass point raycut that Stephen Moran supported.

So you know, just because you're a Trump appoint he doesn't mean that you're necessarily willing to do things as radical as not reappointing a federal Reserve banks these five year the five reappointments historically have been absolutely routine.

You know, they're they're not they're not ever, They've never been consequential in the past.

So to not reappoint a federal resert president because you're afraid that they're not a supporter of much lower interest rates would be without president.

So I'm looking at, you know, a couple of things.

Number one, the Lisa Cook case, hugely consequential.

Number two, where are where are Michelle Bowman and Chris Waller and all this?

And how far are they willing to go in terms of transforming the FED?

You know, basically, you know, dismissing federis or presence because you don't like how they're going to vote on monetary policy would be the end of FED independence.

And I think, you know, to your point, it's remarkable that people are so optimistic about this, because even if it's a twenty percent probability, it's a twenty percent probability of a very bad event.

As you talked at the top of the of the of this session.

You know, if Donald Trump were to get his way and get one percent interest rates, we would have a much more significant inflation problem.

Inflation expectations would become un anchored, and the heel care would steepen.

The bond market vigilantis would almost certainly return, the dollar would weaken sharply.

You know, we would have a pretty big mess on your hands.

And if that's you know, even if that's only a twenty percent probability, that seems like something that you want to price in.

We did some scenarios thinking about how you might euphemistically call a different reaction function of the FED under a new chair.

I mean, one distinguishing feature of all of them, even the more extreme one, is that things look pretty good for a while and then they're really bad.

And just looking at Donald Trump's policies sort of through time, he's been quite good at picking policies that were quite good for a while that he wouldn't necessarily pay the consequences of.

Isn't that a reason to be a bit nervous?

Well, this is exactly why we like to see central bank independence, because central bank independence is thinking about maitre policy, not for the next eighteen months, but for the next few years.

You know, if you have an independence central bank, it can think medium to long term.

If you have a central bank that's controlled by the executive branch and is worried about how things are going to look for the next election, yeah, you can basically make Maitre policy very stimuli, make the economy look very strong, and the inflation consequence of that usually shows through later.

There's been a lot of academic studies that have looked at economic performance based on how independent the central bank is, and the jury is in the more independent the central bank, the better the economic outcomes.

And this is the reason why we've been engaged in a movement to more central bank independence over the last thirty years.

This is not a new trend.

So if Trump moves this in the opposite direction, this is unwinding a lot of momentum that's been in place for several decades.

We're going to run out of time.

But I've got a couple of quick ones.

I mean one is just as a matter of fact, given all the conversation around this, given the focus on the particular candidates, the FED is traditionally the fmc's a bit different certainly from the Bank of England that you tend to have unanimity.

The chairman tends to command a lot of the room, so to speak.

You don't have the governor or the head of the bank doesn't tend to be voted down in their decisions.

That as many people who have said that depends on the respect that the people around the table have for the chair.

Do you think that anybody coming in in these circumstances now is tainted because of the process that's led up to it.

No, I think it depends on how they perform in the job.

So it's sort of up to them when they come in.

Cet A Reserve is a consensus driven institution.

I mean, the chair can lead, but it only leads so far.

So the last meeting is a good example.

There were some people who didn't want to cut rates at the last meeting, so you look at the outcome of the meeting.

All the people except Moran voted for the twenty five basis point raycut.

And so that's basically telling.

You is when the committee has confidence in the chairman.

If the issues are small, the committee is oftentimes willing to defer to the chairman, But if the if the chairman wants to take the interest rates down two hundred basis points and the committee thinks that's inappropriate, then it's not going to happen.

So I think, you know, it's so the chair can lead, but it can only lead so far.

There's a question that came up at a meeting we had this morning.

Do you personally think that Jay Powe will stick around as he suggested?

I think I think he's keeping his options open.

I mean, I think if he's that his presence was standing between good manitary policy and bad manitary policy, then I think he would stay on board.

If he thought that his presence wouldn't make much difference, then I think he'll step down.

So I think he's right now.

I don't think he knows the answer to that question.

So I don't think he knows what he's going to do at this point.

And the final question was just taking us full circle to the discussion we had around where the risks lie in the current decision all this debate.

You know, another potential consequences I've actually heard investors talk about is that in a year or so's time, if you've had a sort of continued boost to the economy from some of these rate cuts and it's actually inflation is starting to come back or come through it could look like you really need to raise rates again, and the fear would be that a slightly more politically compromised FED, whoever the chair is, will not want to do that in the lead up to a mid term election.

Do you think that's another reason for holding now?

Well, I think you know what you're getting to is is that as we start this a discussion about the independence of the FED, even if the FED retains its independence, there's always the question of whether the FED is starting to pull its punches because it's worried about the consequence of it if it doesn't do the administration's bidding.

I mean, already, I've been asked a number of times.

Do you think the FED cut rates in September because of the political pressure of the Trump administration.

I don't think so.

I think Paul believes that it's appropriate to worry about the downside risk to the labor market.

But the very fact that people are asking me that question shows that there's already been some damage to the Fed's credibility.

Yeah, that is just the kind of question that anyone on the FED always hated, and certainly you always used to say that, Bill Dudley, Thank you so much.

Thank you.

Thanks for listening to Trumpnomics from Bloomberg and this special episode was hosted by me, Stephanie Flanders and I was joined by Bill Dudley.

Trumpnomics was produced by some of Saddi and Moses and Dam with help from Amy Keene and special thanks to Rachel Lewis Chriskey.

Sound design is by Blake Maples and Sage Bowman is Bloomberg's head of podcasts.

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