Gregory Mankiw is considered one of the most influential economists in the world. As the Robert M. Beren Professor of Economics at Harvard, the author of several bestselling books and a regular columnist in the Sunday business section in The New York Times, Mankiw is the most frequently quoted author on college syllabi for economics courses. Mankiw served as chairman of the Council of Economic Advisers under President George W. Bush and also served as economic advisor to former presidential candidate Mitt Romney. Mankiw long identified as a Republican until his dissatisfaction with President Trump forced him to switch his party affiliation. N Magazine sat with Professor Mankiw at his Nantucket home to discuss various issues and concerns related to our current economic situation, and he provided thoughtful and valuable insights as to where we may be headed.

We are in a period of economic uncertainty right now. The only thing that I believe people are certain of is it may get worse before it gets better. What do you think has precipitated the situation we are in?

The two words that economists use most often are supply and demand. There have been amazingly profound developments on both sides of that equation. Early in the Biden administration, a lot of economists, including myself, were suggesting that we had too much stimulus in the system and that we were risking inflation. I wrote an article about that in The New York Times in early 2021. I think even those of us who were worried about inflation didn’t envision the 8.5 percent that we’re facing right now. Because in addition to what I think were policy mistakes on the demand side, they were given a variety of supply developments associated with the pandemic, and now Ukraine, that have reduced the demand for goods and services. The combination of too much stimulus on demand and then adverse surprises on the supply side have led to the inflationary situation we find ourselves in now.

Money supply has increased by 40 percent in the last three years. What does that correlate to in a formulaic way?

The quantity theory of money suggests that you’re going to get 40 percent inflation. What is your feeling that the net result is for this dramatic increase? Economists are divided on how much to look at the money supply as the right measure of demand. That’s particularly true when interest rates are very low because the cost of holding cash is not very high when the alternative things are earning only 1 percent. I think economists are of two minds as to what the money supply is. What’s very clear is that there was a lot of monetary stimulus put in because we had a variety of rescue packages in the Trump administration, and then finally the Rescue Plan at the beginning of the Biden administration. The Fed kept interest rates very low, so basically, these rescue plans are financed by printing money and handing it to people. They stuck it in their checking account. Eventually, people are going to spend it. That’s what leads to inflation. As you pointed out, the quantity theory of money is still in my textbook. That’s part of the story, but it’s probably not the entire part of the story because it wasn’t just the money supply. It was also what’s going on, on the fiscal side. It’s quite important.

How bad does inflation get? And how draconian does the Federal Reserve have to get in order to tame it?

That’s the thousand-dollar question. That’s what everybody’s wondering. It’s clear the Fed is raising interest rates in order to slow things down. The question is how much do they have to do that? I don’t think they know. I don’t think anybody knows the answer to that question. The Fed, early on, thought that there were a lot of transitory factors that were going to work themselves out, and they didn’t need to do anything. That was probably too optimistic. But it probably wasn’t 100 percent wrong. I think some of the factors were transitory, and some of those things will work themselves out. I think the inflation is going to be coming down over the next year. I’d be very surprised if it stayed at 8.5 percent, but I’d also be surprised if it came down to their target of 2 percent.

When the consumer goes from paying in the low threes for interest rates to the low sixes, or maybe even mid sixes eventually, how does that not put the total breaks on the middle market housing business?

I think it does. Completely. In fact, I think the sector that’s probably most immediately affected by tightening monetary policy is precisely residential real estate because people see their mortgage rates go up, and they say, “I can’t afford what I thought I could afford...” If you go back a year, the housing market was already booming. The Fed, at that point, was still buying mortgages and keeping mortgage rates down. In retrospect, that was clearly a mistake. They should have looked at the housing market and said, “Huh. This is how the housing market’s booming, maybe we’re putting a little too much stimulus in.” And they should have started tapering earlier, but they didn’t and so we’re now playing a little bit of catch up.

The multiplier effect of a rapidly declining housing market, certainly in terms of consumption, is significant. People aren’t buying washing machines; they’re not buying furniture. Will this inevitably yield a recession?

In economics, nothing is inevitable. I always avoid the use of the word inevitable. I think it’s more likely than not that we’ll have a recession. In fact, I think it’s possible that we’re already in a recession. Because we saw negative growth in the first quarter—the second quarter data is not out yet as we’re speaking, but the people who are guessing what it’s going to look like think it might be negative this quarter. In which case, I wouldn’t be surprised if looking back, we say, “Gosh. The recession started a few months ago.” We’ll find that out. But I think over the next year, I’d be quite surprised if we don’t have a recession.

People in Nantucket are certainly more impacted by the stock market than most, because people either run public companies, have large positions in public companies or manage money of public companies. Economists don’t tend to be stock market prognosticators, but what is your view? Has the market baked in the bad news?

Certainly, a lot of bad news is already priced into the market. You’ve seen a very big decline in both stock and bond prices over the past six months. You’re absolutely right that the best economists are not stock market prognosticators. In fact, I think the best economists avoid that, and most of them follow sort of the standard buy-and-hold policy saying, “I can’t time the market. I’m going to set an asset allocation that I feel comfortable with and I’m going to stick to it no matter what.” That’s certainly what I do. I think the market’s priced in a mild recession right now. If it ends up being a bad recession, I mean, if they go back to 1982 when [then-Fed Chair] Paul Volcker tried to get inflation under control, that was a very deep recession in 81–82. The market is not that priced in.

If you were a betting man, would you predict a mild recession or a serious recession?

I would predict a mild recession because I don’t think [Fed Chair] Jay Powell’s going to decide he needs to squeeze inflation all the way back down to two, quickly. I think he’s going to say, “Well, if it moderates, if it gets down from eight and a half, where it is now, down to four, I can ease up a little bit and we’ll get back to two over the course of time.” That’s my guess.

The economy moves in cycles, which obviously is why we can predict the future because we’ve seen this before. But have we seen this before? We’ve never seen rates go up this quickly. The level of stimulus has been unprecedented in modern times. We now have Ukraine. Have we seen this before?

It’s never exactly the same as anything before, but there’s certain patterns that we see. Go back to the high inflation that we experienced in the ’70s. That sort of started by excessive spending on the Vietnam War in the late ’60s, and then came with adverse supply shocks due to OPEC, also some harvest failures in the early ’70s. So we’ve seen situations where inflation ramps up. My sense is that inflation is not quite as embedded now as it was then. I mean, people back then sort of thought they were living in a permanently high-inflation world. They were expecting 8 percent raises every time they got their annual salary letter from their boss. I don’t think we’re in a situation now where people are expecting persistently high inflation. That could change; these expectations could change. But I think if you look at the best measures of expected inflation, I think people are expecting it to moderate over the next few years. So we’re not quite in as bad a situation as the one that Paul Volcker faced when he was appointed Fed chair in the late ’70s.