# The Unanchored Central Banker: Manoj Pradhan on Inflation, Demographics, and Why AI Won't Save Us

An episode of [Patrick Boyle On Finance](https://invisiblenetwork.ai/podcast/1547740313), 6 May 2026, 51 min.

Audio: https://traffic.megaphone.fm/APO9460254940.mp3

Today, Manoj Pradhan of Talking Heads macro and Fundamenta capital returns to the show to discuss his new book, co-authored with Charles Goodhart, which serves as a highly anticipated sequel to their prescient work, The Great Demographic Reversal. If you thought the recent era of high interest rates and sticky inflation was just a temporary post-pandemic blip, Manoj is here to explain why the future will be nothing like the past. In this episode, we take a hard look at where mainstream economists are getting it wrong. Manoj argues that conventional macroeconomic models suffer from massive "blind spots" because they largely ignore the ever-growing impact of government debt and housing on real interest rates. We also discuss his fascinating premise that the Phillips curve isn’t dead—China had just put it in a coma. As China's own demographic challenges mount and household savings eventually fall, Manoj argues that the consensus belief that China will continue to export deflation to the rest of the world is fundamentally flawed. The Unanchored Central Banker" by Manoj Pradhan and Charles Goodhart. https://amzn.to/4n7hklU Patrick's Books: Statistics For The Trading Floor: https://amzn.to/3eerLA0 Derivatives For The Trading Floor: https://amzn.to/3cjsyPF Corporate Finance: https://amzn.to/3fn3rvC Ways To Support The Channel: Patreon: https://www.patreon.com/PatrickBoyleOnFinance Buy Me a Coffee: https://www.buymeacoffee.com/patrickboyle

## Transcript

[0:00] Welcome to Patrick Boyle interviews.
[0:02] If you've just come over from the main channel after watching
[0:05] my video on inflation, you're in exactly the right place.
[0:09] Today, I'm welcoming back Minoj Prada and I first interviewed
[0:12] Minoj back in 2020 when he and former Bank of England Monetary
[0:17] Policy Committee member Charles Goodheart published The Great
[0:21] Demographic Reversal, a book that went on to be an Amazon
[0:25] bestseller and was listed as the best economics book of the year
[0:29] by The Financial Times. For those who missed my first
[0:32] interview, Manoj studied with me at London Business School, was a
[0:36] university professor, and went on to become the global head of
[0:40] emerging market economics at Morgan Stanley before founding
[0:44] his own macroeconomic advisory firm, Talking Heads Macro.
[0:48] He's still a regular on CNBC, Bloomberg and all of the
[0:52] financial networks you watch, and he advises a list of top
[0:56] tier macro hedge funds. Back in 2020, Minos and Charles
[1:01] were amongst the very first to challenge the mainstream
[1:04] consensus with their argument that the demographic changes
[1:08] meant that inflation would be much higher in the coming years.
[1:12] Given the events of the last few years, his track record on
[1:16] economic predictions has proven to be remarkably accurate.
[1:20] Today, we're discussing their latest book, The Unanchored
[1:24] Central Banker, which addresses the dramatic changes in the
[1:28] economic landscape we've seen since that first book was
[1:32] published. The core premise of their new
[1:34] work is that when it comes to the economy, the future will be
[1:39] nothing like the past. In this interview, I asked Minaj
[1:43] all the difficult questions we get into why mainstream
[1:46] macroeconomic models have massive blind spots when it
[1:50] comes to government debt and housing, and why the much
[1:53] discussed Phillips curve isn't actually dead.
[1:57] We look at the tech sector's favorite narrative and discuss
[2:00] why AI might not magically solve our demographic labor shortages,
[2:06] and discuss why the glory days of central banking might be
[2:10] coming to an happy end as we enter the age of the unanchored
[2:14] central banker. I'll put a link to his new book
[2:17] in the description below for those of you who'd like to check
[2:20] it out. It's great to have him back on
[2:23] the channel. Let's get right into the
[2:25] interview. Welcome back to the channel.
[2:28] It's great to have you back at the last time I had you on your
[2:32] first book, the great demographic reversal had come
[2:34] out, which I think I was the first person to interview you
[2:38] and I said it was the best economics book of the year.
[2:41] And then I feel later that year the FT came out and said the
[2:46] same thing. So there's, there's obviously no
[2:49] pressure on you for, for the the second book now.
[2:53] But you know, to a certain extent this book is kind of a
[2:57] follow up to the original because you predicted that there
[3:02] would be a lot of inflation back.
[3:04] Was it in 2019 when you wrote the first book?
[3:08] So you predicted inflation. You were right about that.
[3:12] And you've now written a follow up book.
[3:14] So where? Where have you gone with the new
[3:17] book? Well, first, thanks.
[3:19] It's, it's great to be back. I actually can't believe it's
[3:22] been that long. And yeah, you were the first one
[3:25] to do it on both times. Now it's a good record.
[3:27] Let's hope it means the same for the book.
[3:31] The inflation thing, I think at that time was really a, a very,
[3:36] very difficult story to talk about because though we had
[3:40] written the book in 2019, it was published only around the first
[3:45] quarter of 2020, by which time the pandemic had already struck.
[3:49] And in fact, I remember I was in and out of hospital.
[3:52] So I could really feel the impact of what was going on.
[3:56] And most of the talk around that time was about deflation.
[3:59] But we felt that the the the combination of the policies that
[4:02] would be put into place, the supply shock that was coming,
[4:06] and the change in the underlying demographic structural story
[4:10] would lead to inflation. The way we've gone with this
[4:13] book is to have a dual focus on what we wanted to do.
[4:17] It is indeed a sequel, and we were trying to do 2 things from
[4:20] here. First is we were trying to
[4:23] address a lot of the criticisms, critiques and changes that have
[4:28] happened. People have responded to our
[4:30] thesis about demography. Events have happened that are
[4:33] really important in terms of fiscal policy, in terms of AI,
[4:36] in terms of China. And to argue whether our thesis
[4:41] still holds where the inflation is over and done with, where the
[4:44] real interest rates lie as a path for real interest rates is
[4:49] more benign than we had thought back in back at that time.
[4:52] And whether the new stories about fiscal policy that have
[4:56] really become so intense after the pandemic will change the way
[5:01] the world looks not only at the economy as a whole, but at
[5:05] central banking in particular. That's the focus of the second
[5:07] book. I see now your book was very
[5:11] much I, I feel you were the first person to really be
[5:15] talking about this idea of how an ageing society is just
[5:21] naturally inflationary. This idea that when you have
[5:25] will say a lot of people either too young to work or too old to
[5:30] work, it means that the few people that are working
[5:33] basically suffer the costs of everything and, and that drives
[5:38] up costs. No one was really talking about
[5:41] that then. It seems to me a lot more people
[5:44] are talking about that now. Do you agree?
[5:47] I think so. I, I think that's that, that's
[5:49] generally true. The the arguments back then, if
[5:53] I remember them vividly well, that essentially demography was
[5:59] associated more with deflation than anything else because at
[6:03] least in financial markets, the prevalent narrative was look at
[6:06] Japan. What we've seen in Japan is an
[6:09] ageing society and it has been associated very strongly with
[6:13] deflation. One of the things we tried to do
[6:15] in our book in in a particular chapter called Why didn't it
[6:18] happen in Japan? Is to point out that what
[6:21] happened in Japan was actually a consequence of benign demography
[6:25] that had kept interest rates low and that had put the world into
[6:28] a deflationary or disinflationary trend for a very
[6:32] long period of time. And that was changing.
[6:34] I think you're absolutely right that both people associate
[6:38] demography with inflation. They look at labour shortages
[6:41] and see that labour shortages can lead to wage growth and wage
[6:44] growth can lead to higher inflation.
[6:46] I think also the the discussion about demography has filtered
[6:50] into academic models and central banking.
[6:53] For example, Christine Lagarde from the ECB regularly talks
[6:57] about domestically generated inflation.
[7:00] One of my favorite central bank economist, Paul Conway of the
[7:04] Reserve Bank of New Zealand, talks explicitly about the
[7:07] things that matter to inflation being dominated at points in
[7:12] time by supply side stories. So I I think you're right, I
[7:16] think demography is being associated with inflation a
[7:18] whole lot more than it was before the book was printed.
[7:22] Now one of the, I think it's early on in your book, you you
[7:26] make a point. I agree with you on this, that a
[7:30] lot of economists are assuming that as societies age that
[7:35] people will save an awful lot more, and you disagree with them
[7:39] on that. You want to elaborate a little
[7:41] bit on those ideas? Yeah, I I'd love to.
[7:43] I mean, this was one of the the most important critiques that
[7:46] that Charles and I wanted to talk about.
[7:49] And the argument is actually it, it's actually very sensible when
[7:53] you, when you hear it the first time.
[7:55] The argument of most conventional models that have
[7:57] incorporated demography into trying to predict what happens
[8:01] to real interest rates is quite simple and, and quite elegant.
[8:06] And the simple argument is, let's say life expectancy
[8:10] increases. A rational person would see that
[8:14] life expectancy has increased and they would understand that
[8:18] they have a longer future and a longer life ahead of them.
[8:22] And they won't be working for the entirety of it, which means
[8:25] they need to save more. And as they save more,
[8:28] particularly for people who are working much more than retirees,
[8:32] that additional saving then flows into bond markets and
[8:35] tends to depress interest rates. But as life expectancy
[8:38] increases, the conventional model would argue that real
[8:41] interest rates go down. Now, now, you and I have have
[8:44] chatted a lot about whether people really behave in this
[8:47] rational fashion. Maybe some do, But I think we
[8:51] would agree that a lot of the evidence doesn't really argue in
[8:54] favor of that. But the biggest point of
[8:56] contention is we think that the models miss something quite
[9:00] significant. And let me explain the the main
[9:03] thrust of it. In any macroeconomic model, the
[9:06] real interest rate is an equilibrium price.
[9:10] And that equilibrium has to be determined by understanding
[9:14] whether the the private sector surplus, which is what would
[9:18] happen if households save more, is greater than the public
[9:21] sector deficit. One of the things that we argue,
[9:24] and I think very intuitively in our book is that we argue that
[9:28] public sector deficits and debt are very, very, very closely
[9:33] linked demography. If you look at population aging,
[9:37] that is going to raise the need for pensions, for healthcare,
[9:42] for looking after people with neurodegenerative diseases
[9:44] through caring and argument is that as societies age, public
[9:50] sector deficits for all of these reasons are going to go up
[9:53] substantially, substantially. And even the current forecast
[9:57] from very creditable organizations like the
[10:00] Congressional Budget Office or the Office for Budget
[10:02] Responsibility in the UK want to state what's going to happen to
[10:05] those deficits. So in our mind and in in our
[10:09] understanding, there's no doubt that the public sector deficit
[10:13] is going to rise by much more than the private sector savings,
[10:17] which means that the real interest rate is going to rise,
[10:20] not fall over the decades to come.
[10:23] Yeah. I mean, this isn't how does this
[10:25] compare when we look at, we'll say the United States where
[10:30] there isn't public healthcare and Europe like is will they
[10:35] have to dial back healthcare provision in Europe?
[10:38] And you know what? What?
[10:40] What? Is the US unscathed by this?
[10:45] It's a, it's a very difficult scenario for the US because
[10:48] there are quite a few things going on. 1st is I think there
[10:51] has already been a wave of changes in pension plan right
[10:54] from defined benefits to defined contributions and that reduces
[10:58] the burden of what the provider has to pay for.
[11:02] The second thing as we all know is that Social Security, which
[11:05] is going to be quite a difficult story, is not a fully funded
[11:09] system. You don't get the Social
[11:11] Security payments and invest them and the investment returns
[11:14] then pay for the payments. It's a pay as you go system and
[11:17] it's a very well known story by that by around 2033, the reserve
[11:22] fund which the Social Security system has drawn for in order to
[11:27] make Social Security payments is going to run out.
[11:31] And at that point in time, the administration, whichever
[11:34] administration is in charge, is going to have to figure out,
[11:37] well, what do we do? Do we reduce Social Security
[11:40] payments? Do we reduce the healthcare
[11:41] provisions? And it's really a tough task.
[11:45] I think both options remain open.
[11:47] Both have significant costs. For example, Germany a decade
[11:53] ago came up with a reform package that basically put the
[11:58] burden of aging and pension spending much more on to the
[12:03] population, at which point in time the participation rates
[12:07] among the elderly in the population went up significantly
[12:10] when they realized they had to save a whole lot more.
[12:13] Or the administration, which is in there, could take the route
[12:16] that most governments have taken and say, well, you know,
[12:18] whatever the shortfall is, we'll bankroll it.
[12:21] And under those circumstances, that would rise much more and we
[12:26] would see the effects of that in financial markets.
[12:29] My cynical guess is that it's going to be more of the latter
[12:33] where the government says, well, we'll reduce our
[12:37] responsibilities to some extent, but we can't just let this thing
[12:41] fall over and take on additional responsibility by issuing debt.
[12:46] It's it's a difficult proposition.
[12:48] I don't think there's any easy way out, but I do think
[12:51] politicians will take the relatively easier route,
[12:54] politically speaking. No, it's, it's an interesting
[12:57] thing because obviously if there wasn't much public debt right
[13:01] now, we wouldn't have to worry too much.
[13:03] You'd just say, well, you know, they'll, they'll, they'll borrow
[13:06] some money, they'll be able to pay for this stuff and then
[13:09] then, you know, they pay that down in the future.
[13:11] But we're now, I think at the highest debt to GDP ratios ever
[13:17] seen outside of wartime. There's at at what point do you
[13:24] know the big nation states run out of borrowing capacity?
[13:28] I I guess borrowing capacity is probably greater than a lot of
[13:31] people would have predicted a few years ago, but is there a is
[13:35] there a stopping point? Again, incredibly difficult
[13:42] question and and it actually brings us to someone of the main
[13:46] points that that we are trying to make, which given the appoint
[13:49] or the upcoming appointment of Governor Warsh who is in favor
[13:53] of shrinking the Fed's balance sheet is really interesting.
[13:56] Let me let me try and explain that a little bit.
[13:58] First, I think the problem is not that any individual country
[14:02] is going through an increase in, in debt to GDP ratios or debt
[14:06] issuance. It's that the, the demography of
[14:10] the advanced economies is so one directional that all of them
[14:15] will have to start borrowing more in order to look after
[14:17] their populations around the same time.
[14:20] I'm, I'm sure in the, in the, in the discussion that we're about
[14:24] to have, we're going to talk about AI, but barring a huge
[14:28] surge in productivity, would just, you know, almost
[14:30] miraculously allows governments to pay back that debt through
[14:34] productivity and higher GDP growth.
[14:36] The the overall nature or the overall direction of leverage
[14:42] issued by governments is going to be the problem.
[14:45] So some countries may issue a little bit more, some countries
[14:48] may take a more pragmatic route, but the overall direction of
[14:51] travel seems to be quite difficult.
[14:54] The the second part of your question is, is equally
[14:56] compelling, right? Is there a threshold of course,
[14:59] ex ante before the fact? We don't really know, but we
[15:03] have clues and we have significant clues.
[15:06] So the experience of the very well sited trust administration,
[15:12] the experience of France in the recent past and even what
[15:16] happened around the Japanese election when there was a
[15:19] discussion about the new administration taking the
[15:22] significantly expansionary fiscal path does give us a few
[15:27] clues. Now a decade ago when interest
[15:30] rates were very, very low or two decades ago when they were
[15:32] falling, I think most of these administrations could have
[15:36] issued a lot. The interest expenses would have
[15:38] been quite low because we were in a disinflationary trend and
[15:41] no one really would have bothered.
[15:42] In fact, that's what happened to Japan.
[15:44] But now what we're seeing is that at positive real interest
[15:47] rates with inflation and real interest rates that are being
[15:50] driven up, the ability of governments to finance
[15:54] themselves at in a very cheap rate has disappeared.
[15:58] And along with that, what we find is that this greater
[16:02] issuance is coming because of demography, which also tends to
[16:06] slow growth down. Financial markets don't like
[16:09] that. As you can imagine, lower growth
[16:12] and higher debt raises an immediate question about when
[16:15] will you pay this back. And if the answer isn't clear,
[16:18] then financial markets start demanding a higher premium for
[16:22] holding those interest rates, which only makes the matter of
[16:25] financing that debt harder. So it's difficult to know
[16:28] exactly when, but we have to pay particular attention to two
[16:32] things #1 the overall direction of travel of the advanced
[16:35] economies, which have been immune from any market pressure
[16:39] for all the decades in which debt has been rising until now.
[16:43] And the second is, in particular, what happens to the
[16:46] fiscal trajectory of the United States, which as we all know,
[16:49] sets the global real interest rate.
[16:53] Now a big argument, one of the most interesting things I think
[16:56] in your book is around this theme that central bankers have
[17:02] possibly had the the wind in their sails up until now.
[17:07] And that that has reached an end.
[17:10] And it sort of ties into this concept of, well, I guess just
[17:14] the falling interest rates over in the long term.
[17:17] But also your dual Phillips curve ideas could could you
[17:21] explain to the audience the the dual Phillips curve idea?
[17:26] Yeah, I'd, I'd be happy to. It's been a pet project of mine
[17:28] and I I think that is the right way to think about inflation.
[17:33] When central bankers talk about core inflation and headline
[17:36] inflation, of course there is there remit, but that discussion
[17:40] misses out on where inflation comes from.
[17:43] The way Charles and I discuss inflation in the book, we split
[17:47] inflation into two components, just quite normal.
[17:51] Almost every central bank publishes data for services
[17:55] inflation and for goods inflation.
[17:58] But what's different about our approach is we allocate these
[18:02] two series to different points of origin.
[18:05] It's it's very well known. Again, as I mentioned, Christine
[18:09] Lagarde from the ECB and Paul Conway from the RBMZ have made
[18:13] this point again and again and again that services inflation
[18:16] tends to be domestically generated.
[18:18] I think that part is, is reasonably well documented.
[18:22] What's less well discussed is that goods inflation is not
[18:27] controlled in the domestic economy anymore and has not been
[18:32] for the last few decades. In fact, after 1990 and
[18:36] particularly after 2000 when China was given most favoured
[18:40] nation status in the United States, goods inflation has been
[18:44] the domain of global manufacturing and particularly
[18:47] China. So these tailwinds that you
[18:49] mentioned, if you look at the data from about the, the year
[18:54] 1990, you see a huge diversions in these inflation trends.
[18:59] What you see is that goods inflation, the, the, the, you
[19:03] know, the prices for washing machines, television, so on and
[19:05] so forth, started around 2 or 3% in 1990.
[19:10] And just a few years before the great financial crisis, it had
[19:14] fallen all the way down to -2%. Which means that, you know, if a
[19:17] new family went to buy a washing machine everyday, the price
[19:21] increase was slower and slower. And eventually actually, the
[19:23] prices started falling. Now that's like an income gain.
[19:26] And that allowed those families to stop putting that money to
[19:30] its services or towards other things.
[19:31] This was a period of benign disinflation from China because
[19:35] it was making life better for everyone through what economists
[19:39] would call a positive supply shock.
[19:40] Then came two episodes, one around the time after the great
[19:45] financial crisis between 2012 and 2015 and one particularly
[19:49] after the pandemic in which China generated Align
[19:53] disinflation, right, because the Chinese economy was weak,
[19:56] because the property market went through a significant downturn
[19:59] and created deflation. In fact, outright, which is not
[20:02] dissimilar to what we're seeing now.
[20:05] And that led to a very sharp decline in goods inflation and
[20:09] services inflation stayed relatively robust.
[20:12] So when we look at it from the central bank standpoint, their
[20:15] argument that they have managed to deliver a core inflation
[20:20] which is very close to target. Actually misses out on the point
[20:24] that most of these changes in inflation came through goods
[20:28] inflation, which is manufactured in China, quite literally
[20:31] speaking, and not really through services inflation.
[20:34] Central banks have had tailwinds at their back, doesn't mean they
[20:37] haven't done their job. They have really tried to make
[20:40] sure that monetary policy was consistent with inflation, but
[20:45] we feel that this would not have been as successful a period
[20:49] without China's help, either in a benign way or a malign way.
[20:53] And a lot of that seems to be coming to an end over the next
[20:56] few decades. We feel China's disinflationary
[21:00] or deflationary impulse that a lot of people are associating
[21:04] right now with its current account surplus is going to
[21:06] disappear because that ageing society will soon start seeing
[21:09] your current account deficit soon as in on a structural
[21:13] timeline. And if you look at the current
[21:16] data, the housing market is beginning to ease up a little
[21:20] bit. The disinflation of the
[21:21] deflation is getting slightly better over a period of time.
[21:26] I, I think it's still a very difficult time for the next year
[21:29] or two to figure out what goes on with China and the
[21:31] disinflation It's admitting into the economy.
[21:34] But the long term doesn't look like central banks will receive
[21:37] much help from that source. They'll have to do their
[21:40] homework by really trying to hurt services inflation, which
[21:44] is a different beast all together because then you have
[21:46] to hurt the labour market. Well, it's interesting 'cause
[21:49] there, there's been a lot of press recently about what
[21:52] they're calling the China shock too.
[21:55] I guess even with the tariffs in the United States, Chinese
[21:59] exports have gone, have have increased.
[22:02] And this is sort of the way China's been dealing with the
[22:06] bursting of the real estate bubble is just to sort of run
[22:10] the factories flat out. If you suppress demand, it means
[22:14] that the local people cannot buy the stuff being manufactured, so
[22:19] it has to be exported. Umm, a lot of that is hitting
[22:23] Europe, obviously. Uh, in particular we see like
[22:26] Chinese electric cars pretty much everywhere.
[22:30] Umm it, it, are we at the end of the road of that?
[22:34] Like, do you think it it is there a point in which China can
[22:37] no longer do this? Does it end because, you know,
[22:42] other countries intervene with, we'll say like tariffs or
[22:45] subsidies or, or is it just that it's no longer value added to to
[22:50] try and grow an economy that way?
[22:53] Well, first I'll say that it it China's is in a difficult
[22:57] position right now where they're trying to balance off quite a
[23:00] few things. But, but let me walk through the
[23:03] conventional argument and then explain the way we see China
[23:08] evolving and what that means for the future.
[23:10] I think the conventional argument is that given the fact
[23:15] that the Chinese policy makers are unable or unwilling to
[23:19] stimulate domestic demand through fiscal transfers, the
[23:22] only choice that they have in order to keep social harmony and
[23:26] the economy going and particularly employment
[23:28] supported is to create export price deflation.
[23:32] And that export price deflation means the world is importing
[23:35] disinflation through Chinese export prices.
[23:38] China has a rising export surplus and that makes matters
[23:42] very, very, very difficult for everyone.
[23:45] Now. Now there are some clear facts
[23:49] that you cannot argue with. Number one, that the Chinese
[23:53] current account surplus has gone up.
[23:54] They are exporting more. Chinese export prices have been
[23:58] falling and that is disinflationary.
[24:01] It has hit a lot of places very hard.
[24:04] For example, the German economy when it comes to the auto sector
[24:09] has really been hurt very badly. If you take an Uber, you're more
[24:12] likely to get a BYP than almost any of the car.
[24:16] And they have really, really surged in the production of
[24:19] solar panels as well, which is again a very disinflationary
[24:22] story. So, so there is a lot of data
[24:25] that backs up this view. I, I do feel that there is a
[24:29] different interpretation of the Chinese economy.
[24:31] So let's take a look at it from, I think the, the, the view that
[24:35] we do. For example, the forces that are
[24:39] creating disinflation or deflation in export prices in
[24:44] China are not is strategy that says Chinese policies makers
[24:49] want to deflate export prices and create employment only
[24:54] through that Channel. In fact, what's happening is the
[24:56] Chinese economy is going through a period of deflation
[25:01] domestically and those domestic deflationary processes are
[25:05] feeding into export prices. Where's the domestic
[25:08] deflationary pressure coming from?
[25:09] It's coming from two sources. Number one, it's coming from
[25:12] housing. Chinese policy makers had really
[25:16] wanted to bring the housing markets rolled down quite
[25:19] aggressively from 2012 to 2015, but in 2015 they ended up
[25:23] bailing out the property sector and then the.
[25:25] China, they've very much managed to do that right.
[25:30] They kind of, they kind of walked it a little bit back and
[25:33] then it started rising again. They built more houses.
[25:36] So this is the second part of that adjustment.
[25:38] It's coming from there. But also, I think there was
[25:41] something strategic that they didn't think would go so far.
[25:45] So if you look at how Chinese policy makers have subsidized in
[25:50] the past, the electric vehicle industry, the nickel cadmium,
[25:55] lithium battery industry, and the solar panel industry, there
[25:59] were significant subsidies. And that led to huge competitive
[26:03] fights and really price wars that have lasted for two, 3-4
[26:07] years within the Chinese economy.
[26:09] And that's being transmitted into export prices.
[26:12] Chinese policy makers don't like this.
[26:14] The reason they don't like this is because they've got a huge
[26:16] stockpile of debt and allowing deflation to become a persistent
[26:20] thing makes debt much, much, much harder to pay back.
[26:24] So I think while there is no doubt that the current account
[26:27] surplus is rising and export prices have been falling, it's
[26:30] very difficult to believe that Chinese policy makers using that
[26:34] as a strategy. The final point I would make is
[26:37] increasingly over a period of time, employment, profits,
[26:41] business investment have all been in the private sector and
[26:45] they've been in the services sector.
[26:46] In fact, manufacturing employment in China has been
[26:48] falling persistently for decades.
[26:50] So using export prices in a policy of deflation which hurts
[26:54] you at home in order to generate employment in the sector whose
[26:59] employment footprint is shrinking makes very little
[27:01] sense from that point. I think these trends may persist
[27:05] for a while. It's very difficult to call the
[27:06] short term, but over a medium term I don't think the policy of
[27:10] deflation or thinking about using it to create employment
[27:14] makes any sense from the Chinese standpoint.
[27:17] Now, you did have a a chapter, I quite liked it, in which you
[27:22] didn't really try to make any out outrageous predictions on,
[27:26] on the topic of AI, but you did have some skepticism over the
[27:31] idea that that somehow AI will help fix the labor shortage.
[27:37] Do you want to dig into that a little bit?
[27:40] Yeah. The first thing I'll say is,
[27:42] look, AI, the reason we're all excited about this is the
[27:48] potential for productivity. You know, in the, in the years
[27:50] that I was teaching economics for undergraduates, many grad
[27:54] students, I used to tell them if you won half the marks in your
[27:57] question to have anything to do with growth or inflation, just
[28:01] right productivity, because that fixes almost all problems in
[28:04] society. And that's the huge promise.
[28:06] But it's too early to tell. We really are not technology
[28:09] experts, nor do we have any trend that we can depend on as
[28:14] far as AI is, is concerned. And in fact, we, we, we make a
[28:18] few points about what AI could do.
[28:20] I'll, I'll say very briefly that AI doesn't offset demography
[28:25] completely and some things that actually reinforces it, right.
[28:28] For example, think about the amount of CapEx that you have to
[28:33] deliver to have AAI as a really widespread phenomenon in your
[28:38] societies. That number is north of 600
[28:41] billion in the US right now and that is competing for capital at
[28:45] the same time that U.S. debt to GDP ratios have passed 100%, as
[28:50] you mentioned before, which means real interest rates are
[28:54] going to rise. If that level of CapEx
[28:56] investment does carry on, whether it's profitably
[28:59] profitable, profitable or not. Excuse me.
[29:02] Second thing is look at look at the electricity prices, right?
[29:05] Electricity prices are going to feed into everything.
[29:07] If your data centers cannot keep up with demand or they lag even
[29:11] just a little bit behind the demand for energy that comes
[29:15] from both non AI sources and AI sources are going to drive up
[29:19] energy needs. So we need a solution for that,
[29:22] but the point. A lot of a lot of what you were
[29:24] saying was about AI replacing sort of more cognitive work
[29:30] versus manual. And this almost goes back to
[29:33] your dual dual Phillips curve idea that the the work that the
[29:40] type of work that is needed in an aging society is often more
[29:45] manual. It's not so much that you need
[29:47] something to help you write an e-mail or or, you know, generate
[29:51] an image for you, but you need someone to to look after an
[29:55] elderly relative or, you know, do work around houses and that
[30:00] kind of thing. And there's those are are kind
[30:03] of the jobs that you point out are actually have become more
[30:07] valuable in the Western world where essentially we have to pay
[30:12] up for the cost of having someone present to do a job.
[30:17] Well, I'm not, I'm not saying this because you're here
[30:21] chatting with me, but but very few people make that connection
[30:24] and I think you're absolutely right.
[30:25] Well, I'll give you 2 brief answers. 1st is the answer that
[30:29] I didn't really give to your earlier question.
[30:31] So let me do it now, very briefly.
[30:34] When it comes to substituting labour demand, what we argue is
[30:38] that the main concern most people have is about a collapse
[30:42] in in labour demand. It could happen, we're not sure.
[30:45] We think it's unlikely. But if it does happen, what I
[30:48] think the argument doesn't go far enough in saying is that
[30:52] knowing how policy makers have reacted, it's almost inevitable
[30:57] that some form of universal basic income will have to be
[31:01] rolled out if this problem becomes a very serious one.
[31:04] And then how do you finance it? If you ask profit making
[31:08] companies from who benefit from AI to keep all the profits and
[31:11] you ask everyone else to shell out all this universal basic
[31:14] income, it's going to be an incredibly unpopular policy.
[31:16] Instead, what will have to happen is that the benefiting
[31:19] companies will have to finance universal basic income, which
[31:23] reduces some of the benefits from AI.
[31:25] Second thing we'd argue is it creates winners and losers.
[31:28] So for example, if you looked at the the integration of China
[31:33] into the global manufacturing system after it received most
[31:36] favoured nation status in the year 2000, manufacturing
[31:40] employment in the United States actually fell by 4 million.
[31:44] That's not great, but what happened was the, the rise of
[31:48] China led to falling inflation, falling interest rates, so that
[31:52] overall employment in the United States actually went up by
[31:55] 11,000,000 for a gross number. And as a net number, it went up
[32:00] by 7 million. And at the same time, Chinese
[32:03] internal migration was about 200 million people moving to pick up
[32:07] these jobs, which really benefited the global economy.
[32:10] Now, the, the second point that you made, it is undoubtedly the
[32:15] case that what AI does is affect cognitive work, which then feeds
[32:20] into the whole Phillips curve argument.
[32:22] The the, the point we tried to make is you need some
[32:25] manufacturing jobs actually to be lost and some of these tasks
[32:30] to be reduced because with the shrinking society that also has
[32:34] an ageing population, you are going to require people to care
[32:38] for the elderly. Maybe that some of that can be
[32:41] helped through automation and through better cognitive
[32:45] automation that that could really be something that changes
[32:48] the picture. We don't know yet, but I think
[32:51] what we are trying to argue is that what AI cannot do yet, and
[32:56] perhaps it may never be able to do, is really replace the
[33:00] workers who are tasked with looking after the elderly.
[33:04] Which means that those workers are then taken away from what
[33:07] you and I would call productive work for the economy.
[33:11] And from the economy's perspective, they're doing a
[33:13] very, very, very rewarding social task.
[33:16] But that social task doesn't contribute to future
[33:18] productivity growth. That is the problem that I think
[33:22] we're going to have to solve over a period of time.
[33:25] Whether AI becomes a big thing or not.
[33:26] It's going to be a very difficult task and I don't think
[33:29] that is something that's on the radar of most people.
[33:32] Now you you had some interesting points as well on AI and
[33:37] inequality. I think in general, when people
[33:41] look at AI, their their take on inequality is not something you
[33:47] can argue with because we see this playing out right now
[33:50] before our eyes. You see that large companies,
[33:53] the hyper scalers or the people who have really come out with
[33:56] these new models are the ones who stand to benefit the most.
[34:00] It looks like a lot of really experienced workers would
[34:06] replace the tasks of people who do regular jobs and that could
[34:11] mean an increase in inequality. But but we see it slightly
[34:14] differently. We think that the the rise of
[34:18] AI, if it becomes pervasive, actually leads to falling
[34:22] inequality. Let me explain why.
[34:25] Sometime back I was sitting and trying to work through numbers
[34:29] for South Africa and then moving on to a few other economies and
[34:34] I was working with Claude and trying to really build models
[34:39] that simulate how growth and inflation and everything works.
[34:43] A fantastic job and it's something that would have taken
[34:45] me 3 weeks. That was done within a day or
[34:47] two. Now what we are arguing is that
[34:50] kind of access to information means a lowering of inequality
[34:56] through three channels. Number one, it means that
[34:59] workers who have not spent enough time in education or
[35:04] picked up a lot of the skills, they have access to those skills
[35:09] now. They have to be able to
[35:10] understand what they're asking for and ask AI the right
[35:13] questions so that it can give them the right answers.
[35:16] But their ability to access those technical skills, which
[35:21] would not have been possible without a huge amount of time
[35:24] building human capital, is now within your reach.
[35:28] Which means the middle section of the workforce, the labour
[35:31] force, can lift its own productivity levels up.
[35:35] The second thing to keep in mind is that small businesses and
[35:39] medium sized businesses can replicate processes that only
[35:43] large companies are able to do. The reason I talked about Claude
[35:46] building me a simulation model is that that's something that a
[35:50] large company could do easily because it has employees and the
[35:52] resources to do it. Otherwise, I would have had to
[35:55] hire a developer, I would have had to get simulation models
[35:58] going, and that would have taken a substantial amount of my time
[36:01] away from my core interest, which is pure economics.
[36:06] And I haven't had to do that. Similarly, small firms and
[36:08] medium firms can use AI as CFOs, as people who give them basic
[36:13] legal reference, and that could lead to a significant
[36:16] improvement in their productivity and their ability
[36:19] to acquire past that they normally would not have access
[36:22] to. And the third form in which
[36:24] inequality could fall is emerging markets.
[36:27] Now, one of the main problems in emerging markets is that they
[36:30] may have large populations or small populations, but what they
[36:34] definitely lack is large pools of skilled human capital in many
[36:40] economies where they've got a certain critical mass of people
[36:43] who can do a number of tasks, but they lack that elite
[36:47] workforce or a larger number of well educated workers.
[36:52] The AI can really help augment human capital in a way that just
[36:56] would not have been possible. When you look at the IMF, one of
[36:58] the first recommendations they give emerging markets is
[37:02] education, education, education. Now you can get that fast track
[37:06] and really allow these economies to catch up with the West in a
[37:09] way that would not have been possible.
[37:11] Yeah, it's interesting. I, I read a paper, I think I was
[37:15] telling you about this the other day on the topic of how AI seems
[37:20] to boost the output. Like really helps the sort of
[37:23] average worker and brings them up to the highly skilled worker
[37:27] level. While highly skilled workers,
[37:29] they're able to use it, but it doesn't necessarily boost them.
[37:33] But to a certain extent, you know, if there's a machine that
[37:36] can do that, that you, you would possibly expect maybe a, a
[37:41] levelling of incomes on that front, right?
[37:44] I think so. And you, you, you were
[37:46] absolutely right when we had that discussion.
[37:49] And I think one of the other points you made also had perfect
[37:51] validity, right. And if you look at the number of
[37:54] people involved in both those cohorts, the macroeconomic
[37:57] impact of that could be very different.
[37:59] So let's say in general that a worker with modest levels of
[38:04] human capital is about 40% of the labour force in the economy
[38:10] and people with elite skills are about 2% of the economy.
[38:15] Let's say the elite workers productivity goes up by 50% and
[38:21] the average workers productivity goes up by 30 or 40%.
[38:25] Even then, the benefits that they accrue in a macroeconomic
[38:29] sense will far outweigh the benefits to the economy from the
[38:34] elite workers going up in a mass sense, in a consumption sense,
[38:37] in a wage mass sense. And so the impact of raising the
[38:41] productivity of the average worker from a macroeconomic
[38:44] standpoint is clearly the much, much, much bigger of the two.
[38:49] And I think it leads to not only a reduction in inequality in a
[38:54] macroeconomic sense, but it also lifts all boats, but it lifts
[38:58] the middle educated workers boats by significantly more.
[39:02] Now, the final chapter of your book is on the interaction
[39:08] between central banks and politicians.
[39:11] And we've kind of seen this play out a little bit already in the
[39:15] United States, that when, you know, when politicians clash
[39:19] with central bankers, you know, we, we, you know, people get
[39:23] upset. We talk about a loss of
[39:25] independence and so on. But you make the argument that
[39:30] up until now, like over the last 30 years, because central
[39:33] bankers have had an easy job where they essentially get to
[39:37] put more booze in the punch bowl, politicians have been
[39:41] happy with them. You make the argument that in
[39:44] the coming years, as they they find themselves taking the punch
[39:48] bowl away more and more, that they will clash with
[39:51] politicians. And in those scenarios, the
[39:53] politicians do win. Do you want to elaborate a
[39:57] little bit on that idea? I'd love to.
[40:00] And in fact, actually the, the, the book comes out in an
[40:03] incredibly interesting time. And we had a sense about this
[40:08] kind of conflict in our first book as well, but it has really
[40:14] accelerated significantly more than we would have imagined back
[40:17] there back then and. It also connects a little bit
[40:22] with a question that you had earlier, which is that central
[40:25] banks have had tailwinds in fighting inflation.
[40:28] And we talked about the role of China and the roads of the role
[40:31] of goods inflation. But really in a political sense,
[40:33] if your central bank is cutting interest rates, if the cost of
[40:36] borrowing is going down, if people have access to credit and
[40:39] they use that to to buy homes and house prices are going up
[40:42] because of low interest rates and you can take holidays and
[40:46] and borrow money at cheap rates. That period, everyone's
[40:50] thrilled. What's not to love?
[40:51] Everyone feels richer. Everyone feels like they have
[40:54] more access to wealth. It feels like they're on the
[40:56] right way. And when that story changes, a
[40:59] lot of people are upset, not least governments.
[41:02] It is much easier to get re elected when the populace is
[41:05] feeling more energized. They find borrowing more
[41:10] accessible, house prices going up and makes more sense to to
[41:15] maintain that story. Unfortunately, those tailwinds,
[41:18] if they have disappeared or at least are fading very quickly,
[41:22] leads to an unanchoring of the central bank's ability to fight
[41:25] inflation. So the reason for the title
[41:28] unanchored central banker is not because politicians are fighting
[41:33] central banks, but it is a consequence of the fact that as
[41:37] demography turns and fiscal policy becomes more and more and
[41:42] more difficult to deal with, central banks are going to find
[41:46] it much harder to fight inflation single mindedly as
[41:50] they did in the past. So, for example, suppose
[41:52] inflation is a problem and, and where we are today is actually
[41:56] so fascinating because it's a microcosm of that story.
[42:00] Suppose inflation is a problem. Over the next few months,
[42:05] central banks might try and fight that inflation.
[42:08] In fact, even in the Federal Reserve, where no hikes were
[42:11] really priced in, you saw through the three dissenters who
[42:15] had a pretty hawkish tilt arguing that look at this, the
[42:18] next move could be a hike or a cut.
[42:21] And so when that happens, you start seeing repercussions in,
[42:25] in, in, in fiscal policy. So if you look at the United
[42:28] States budget, for example, about 70% of the financing is
[42:31] done through short term interest rates.
[42:33] If you raise the Federal Reserve's policy rate, the cost
[42:36] of financing that debt goes up. And that means deficits rise.
[42:41] And if the deficit rises, it creates some financial
[42:43] instability right now, but it also means that in the future to
[42:47] fund the deficits that have grown, run higher inflation.
[42:51] So you can't really fight inflation aggressively in a
[42:54] highly indebted society. And that puts the central bank
[42:57] in conflict with the government. If the government could have
[43:00] more benign fiscal policies and turn away from using policies
[43:05] that lead to greater expansion of deficits and debt, the
[43:08] central bank would have a much easier task on its hand.
[43:11] But governments appoint central bankers, and if they find that
[43:16] it's easier to appoint central bankers who are more willing to
[43:19] accept the government's policies as a given and then allow those
[43:25] fiscal policies to be financed more easily, perhaps they feel
[43:29] that this is the way things should go.
[43:31] But as you and I discussed the other day, this is not something
[43:34] that's palatable to everyone. If you have expansionary fiscal
[43:37] policy and expansionary monetary policy, financial markets, and
[43:41] indeed a lot of people would stop worrying that inflation is
[43:44] around the corner, and then bond yields would not be able to come
[43:47] down, which means the cost of borrowing would actually go up.
[43:51] Yeah. Very difficult.
[43:53] Yeah. I mean, as as a bond investor,
[43:55] it's not a very attractive picture that the government
[43:58] wants to borrow more and wants to allow inflation to occur like
[44:03] these are these are the exact opposites of what you want as a
[44:06] a lender? I think so.
[44:09] And the the, the associated problems with that is that as
[44:16] the willingness of the central bank to by government issuance
[44:22] fades, that means that private investors have to absorb more
[44:27] and more. And when we think about one of
[44:29] the policies that incoming chair Wash wants to implement, it's a
[44:35] reduction in the size of the balance sheet.
[44:38] Now the deficit size isn't coming down.
[44:40] In fact, there are chances that deficits could keep rising for a
[44:43] very, very, very long time and by much more than is forecast.
[44:48] That gap, if the central bank buys a very small amount of that
[44:52] government issuance is going to keep growing.
[44:54] And as it keeps growing, I think you'll find that financial
[44:57] markets will stop demanding a higher and higher premium, which
[45:01] means higher real interest rates.
[45:03] In our opinion, that's going to lead to significant financial
[45:06] instability. So in periods like that, it
[45:08] seems almost inevitable to us that the central bank balance
[45:12] sheet is going to have to rise in order to keep the issuance of
[45:17] the private sector has to absorb to a certain manageable level.
[45:21] And if that happens, I don't think this policy of keeping
[45:25] central bank balance sheets very low for a very long period of
[45:28] time is likely to be sustainable.
[45:29] Something will have to give if you are to maintain some kind of
[45:33] financial stability in the economy.
[45:36] Now we talked about this a little bit privately.
[45:38] I don't think it's in the book, but the the current approach of
[45:44] descent where he is issuing a lot of short term debt rather
[45:49] than issuing across the curve as as central banks, at least U.S.
[45:55] central banks have typically done.
[45:58] And I make the argument that this is basically just a big bad
[46:02] that interest rates at least at the long end of the curve have
[46:05] to come down. There isn't any good reason I
[46:10] can see him particularly based upon your research.
[46:14] And there was also an interesting paper I sent over to
[46:17] you from, uh, from Posen on this topic of, you know, he equally
[46:22] predicts high inflation. Umm, it seems to me maybe a bit
[46:28] of a problem, uh, to be or, or a big gamble to be only issuing
[46:34] short term debt because of course, if rates do go up in the
[46:37] long run, how do you deal with that?
[46:42] Indeed, the the discussion we had at that time was a a
[46:46] difficult one to have because it means that the outlook for every
[46:50] economy in the world changes dependent on how the US
[46:54] economic, fiscal and financial price profile changes over a
[46:59] period of time. You may be frugal, but if the
[47:01] cost of borrowing in the US goes up, your cost of borrowing is
[47:05] going to go up as well. So coming to the point that that
[47:09] you made, I think it's, I think it's a difficult proposition.
[47:13] The, the argument that Besson had is, is not inconsistent.
[47:19] I think what he wanted to do was to generate higher growth to
[47:24] keep interest expenses down and therefore bring the deficit to
[47:28] GDP ratio down to about 3% by the end of this Trump
[47:32] administration. Now there are a couple of
[47:34] problems with this. First is every emerging market
[47:38] experience tells us that the credible way to bring down
[47:42] borrowing costs is not to address interest expenditures by
[47:46] themselves. You bring down the primary
[47:49] deficit, which means the new spending over revenues that
[47:54] you're generating every year. If financial markets see that
[47:58] you are willing to curb that deficit year after year, it's
[48:02] telling you that there is a credible path to lower inflation
[48:06] in the future and markets give you the benefit of the doubt.
[48:09] Similarly, if your primary deficit goes down, the impulse
[48:13] into spending in the economy is definitely lower.
[48:17] And under those circumstances, you're running tightish fiscal
[48:20] policy, and then you can have counteracting easy monetary
[48:24] policy that is completely consistent.
[48:27] The difficult proposition that we have over here is that
[48:32] deficits under the Trump administration are likely to go
[48:35] off for the next few years. There is a possibility that some
[48:39] of those deficits can go down in the future, but we'll have to
[48:42] see what happens in the next presidential election before we
[48:45] can really be certain about that.
[48:47] These deficits going up means that fiscal policy is
[48:50] expansionary. If monetary policy is also
[48:52] expansionary, then exactly as you said, inflation doesn't come
[48:56] down. The size of the deficit
[48:59] definitely makes investors demand higher.
[49:01] Real interest rates and overall real interest rates and
[49:04] inflation together mean that nominal interest rates stay high
[49:07] for the future. Cyclically that could change.
[49:10] Cyclically you can have a periods in which the labor
[49:13] market we can substantially because real interest rates go
[49:17] up or because of shock like the Iran war hits the economy and
[49:21] really take spending down. It hasn't happened yet.
[49:24] Don't know how that will pan out in which interest rates fall,
[49:27] but if the fiscal profile doesn't change, then using
[49:32] falling interest rates at the front end through monetary
[49:35] policy cuts does not usually lead to falling interest rates
[49:39] at the long end. It does not lead to lower
[49:41] inflation and it's very, very, very difficult path to really
[49:45] tread successfully well. Thank you very much for your
[49:49] time. I really enjoyed the book and I
[49:52] would recommend it to my viewers.
[49:54] It's, you know, a great follow up to the original book.
[49:57] You don't have to have read the original book to to enjoy this,
[50:01] but I think it's a really interesting look at what's going
[50:06] on in economics and in central banking right now.
[50:10] It's a very interesting look at demographics that I, I think has
[50:17] been been really original and continues to be.
[50:20] So, you know, once again, best of luck with the book.
[50:23] I imagine it'll be a huge seller like the last one.
[50:26] And thanks again for coming on the podcast.
[50:29] Thanks. Thanks for having me, Patrick.
[50:31] I I enjoyed the conversation, as was the case the last time as
[50:34] well. I'm I'm really glad you enjoyed
[50:36] it. We don't really know if we know
[50:38] all the answers, but I hope it provokes questions in the minds
[50:43] of of everyone, you and your viewers included.
[50:45] Thanks again for having me. Thank you.

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