Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 2: I'm Jill Wysenthal and I'm Tracy Alloway.
Speaker 1: Tracy, I would say the last few weeks, in a
Speaker 1: very real way, I would say optimism over the soft
Speaker 1: landing scenario, or at least the end of the raid
Speaker 1: hikes has become like deeply conventional wisdom.
Speaker 2: I think I would agree with that, although I think
Speaker 2: it's sort of started in the summer. We saw some
Speaker 2: inklings of it then, but you're right, it really seems
Speaker 2: to have crystallized in recent weeks. And of course the
Speaker 2: irony is that going into twenty twenty three, the consensus
Speaker 2: was really for recession. We had a number of people
Speaker 2: who were talking about the outlook for the economy this
Speaker 2: year and how bad it might be, and then going
Speaker 2: into twenty twenty four, it seems like we've completely flipped around.
Speaker 2: So the hills are alive with the sound of soft landings.
Speaker 1: Yeah, and I think you're right. Obviously, twenty twenty three
Speaker 1: has broken a lot of people's brains. Probably a broader theme,
Speaker 1: which is that the entire COVID cycle, people have been
Speaker 1: looking at it through the lens of a traditional business
Speaker 1: cycle or macrocycle, and it feels like a lot of
Speaker 1: that just hasn't worked, starting from probably the fast rebound
Speaker 1: in late twenty twenty oh totally.
Speaker 2: So I feel like the indicator that everyone was looking
Speaker 2: at in sort of late twenty twenty two early twenty
Speaker 2: twenty three was the yield curve, the inverted yield curve,
Speaker 2: and there was this discussion of how you know, this
Speaker 2: is the traditional harbinger of a recession, but maybe things
Speaker 2: are different this time for a variety of reasons. And
Speaker 2: then this year, you know, fast forward to November, sort
Speaker 2: of late October of twenty twenty three, it feels like
Speaker 2: the other indicator that everyone is starting to talk about
Speaker 2: or was starting to talk about, is the PAM rule.
Speaker 2: So the idea that you know, one measure of unemployment,
Speaker 2: the moving average, has been moving up, and traditionally this
Speaker 2: indicates an upcoming recession because unemployment increases non linearly in
Speaker 2: every business cycle. And supposedly this was a hard and
Speaker 2: fast rule. But as we discussed with Claudia on one
Speaker 2: of our episodes of Lots More again, maybe things are
Speaker 2: different this time.
Speaker 1: I do think it's important that you bring that up,
Speaker 1: because it does feel like the labor market situation is
Speaker 1: kind of the fly and the ointment of the soft
Speaker 1: landing scenario, which is that there's clearly some kind of softening.
Speaker 1: I guess I would say in the labor market, it's
Speaker 1: the question how far does that go? When will the
Speaker 1: FED have to cut? Should the FED be taking out
Speaker 1: some sort of insurance cut sooner rather than later to
Speaker 1: forestall a downturn? All big macro questions. We are nowhere
Speaker 1: near the end of understanding this macrocycle, and I think
Speaker 1: we got to get a better handle.
Speaker 2: On the good news about this macro cycle is I
Speaker 2: feel like twenty years from now, fifty years from now,
Speaker 2: there will still be studies coming about exactly what.
Speaker 1: Just happened unambiguously. I am confident on that. All Right, Well,
Speaker 1: we do literally have the perfect guests to help us
Speaker 1: understand this moment in macro, what happened in twenty twenty three,
Speaker 1: what we should be looking forward to in twenty twenty four.
Speaker 1: I'm thrilled to welcome back on to the show, Jan Hatzias.
Speaker 1: We've had them on a few times. Jan Hatzias, chief
Speaker 1: economist at Goldman Sachs. Joan, thank you so much for
Speaker 1: coming into the studio and coming on odlots.
Speaker 3: It's great to be back with you, Joe and Tracy.
Speaker 3: Always wonderful to be here.
Speaker 1: Thank you so much. You put out a recent note,
Speaker 1: and what I really loved about it is that, you know,
Speaker 1: there's this cliche that many markets journalists, maybe even tracing
Speaker 1: myself at times, have used, where it's like, blah blah blah,
Speaker 1: happens now here comes the hard part. It's just one
Speaker 1: of those things that people love to say. It's this trope.
Speaker 1: All the easy money has been made, now here's the
Speaker 1: hard part. Inflation's gone down. Here, here's the hard part.
Speaker 1: You and she said the opposite. You said, actually coming
Speaker 1: up next, there's quite a bit of disinflation in store,
Speaker 1: and that this stage of further declines and inflation should
Speaker 1: be the fairly easy part. That we've passed the hard
Speaker 1: part of fighting inflation. What do you let's start there?
Speaker 1: What gives you confidence that actually, regardless of what happened,
Speaker 1: there's more disinflation in the pipe.
Speaker 3: You're right. The title of our annual Outlook Report, which
Speaker 3: we published a couple of weeks ago, is the hard
Speaker 3: part is over. And think the reason why I think
Speaker 3: the hard part is over is that we have a
Speaker 3: proof of concept that we can bring down inflation and
Speaker 3: rebalance the labor market without having to crush the economy
Speaker 3: and put the economy into recession. And I think we've
Speaker 3: seen that very clearly in twenty twenty three. We've seen
Speaker 3: it in the US, but we've seen it much more
Speaker 3: broadly across G ten economies and EM economies that saw
Speaker 3: a big surge in inflation in twenty twenty one, Inflation
Speaker 3: has come down. If you take an average of all
Speaker 3: of these economies that saw a large and unwanted inflation
Speaker 3: surge across DM and EM went to six percent core
Speaker 3: inflation in twenty twenty two or six percents come back
Speaker 3: down to about three percent on a sequential, annualized basis
Speaker 3: without any deterioration in the labor market across these economies. Yeah,
Speaker 3: in some places you've seen some increases in the unemployment rate.
Speaker 3: We have seen some increase in the US. In others
Speaker 3: you've seen some decline, but the average actually has been
Speaker 3: basically flat. And to me, that's very very telling.
Speaker 2: Well, can I ask you something specifically about the US
Speaker 2: economy because I was reading another Goldman publication. You know
Speaker 2: this one. In addition to the outlook that Joe just mentioned.
Speaker 2: This was sort of a Q and A between you
Speaker 2: and someone internal at Goldman and they asked you about
Speaker 2: long and variable lags in monetary policy, and you sort
Speaker 2: of suggested that you don't really think that's a thing.
Speaker 2: So my question is, how do you square the idea
Speaker 2: that the hard part is over, that there's more disinflation
Speaker 2: with the idea that monetary policy, you know, maybe the
Speaker 2: long and variable lags aspect of it is over egged.
Speaker 2: Is it just a matter of degree? It's like the
Speaker 2: majority of disinflation has happened, and now we're going to
Speaker 2: see little bits and pieces.
Speaker 1: Well.
Speaker 3: On inflation, I think we will see additional declines in
Speaker 3: a few areas. One that's I think very clear is
Speaker 3: housing rent inflation and Honer's equivalent rent inflation is very
Speaker 3: likely to come down further. It's still running at about
Speaker 3: six percent on a again sequential annualized basis, and just looking
Speaker 3: at alternative rent indicators and where they've been running and
Speaker 3: continue to run, we would expect that to get back
Speaker 3: down to the three to four percent range by the
Speaker 3: end of next year. In the core CPI rent and
Speaker 3: owner's equivalent rent has a forty percent weight in the
Speaker 3: core PCE index, it still has a seventeen percent weight,
Speaker 3: So these are are pretty significant reasons for expecting further deceleration.
Speaker 3: We've also seen a lot of labor market rebalancing. Job
Speaker 3: openings have come down substantially. The quid rate has gone
Speaker 3: back to where it was in February twenty twenty. That
Speaker 3: is still feeding through to the wage numbers, and I
Speaker 3: think that's another source of disinflation, and then there's still
Speaker 3: some disinflation to come on the core goods side. So
Speaker 3: in that sense, I think the lagged effects of what's
Speaker 3: already happened are indeed important. Where I don't agree with
Speaker 3: the sort of maybe cliche of long and variable lags
Speaker 3: is if I think about the gap between a monetary
Speaker 3: policy shock and the maximum impact on the growth rate
Speaker 3: of GDP, which for me on the growth side is
Speaker 3: really the most important question. How long does it take
Speaker 3: until I see the maximum impact on growth? We think
Speaker 3: that's only about two quarters, which means that since the
Speaker 3: FED was most aggressive in tightening policy starting at the
Speaker 3: June twenty twenty two FORMC meeting, the biggest impact occurred
Speaker 3: really in late twenty and twenty two, early tw and
Speaker 3: twenty three, So it's quite important to think about what
Speaker 3: question you're asking. There are long lags in terms of
Speaker 3: the impact on inflation. There are even some pretty long
Speaker 3: lags in terms of the impact of monetary policy on
Speaker 3: the level of GDP. But as a forecaster, what I
Speaker 3: care most about is the maximum impact on the growth rate.
Speaker 3: Because if I have a non recession forecast and we've
Speaker 3: already gotten through the biggest hit from the tightening without
Speaker 3: the economy having entered recession. Now we're still seeing some
Speaker 3: negative impulses, that's it's not going to worry me that
Speaker 3: much because we've already survived the biggest hit.
Speaker 2: Yeah, and since you mentioned the non recession call, I
Speaker 2: feel that we have to mention Joe that the last
Speaker 2: time we had yan on was in August I think
Speaker 2: of two, twenty twenty two, in an episode titled The
Speaker 2: Narrow Path to Avoid Hard Landing, basically laying out a
Speaker 2: lot of the soft landing scenario that seems to be
Speaker 2: coming to fruition.
Speaker 1: So, yeah, if we've been able to see all of
Speaker 1: this realized disinflation, prime more to come without too much
Speaker 1: damage to the labor market. You know, the story goes,
Speaker 1: the FED hikes rates, it slows demand, people lose their jobs,
Speaker 1: prices compressed, but we didn't get the massive job losses.
Speaker 1: How do you even think about the link between the
Speaker 1: rate hikes that we've seen and the disinflation we've seen.
Speaker 1: Are they connected? Is it the kind of thing where
Speaker 1: it's not entirely clear what has been the Fed's role
Speaker 1: in slowing down inflation.
Speaker 3: I think they're connected in the sense that the economy
Speaker 3: grew more slowly than it otherwise would have done. If
Speaker 3: the FED had not tightened policy, we would have seen,
Speaker 3: you know, stronger growth and higher inflation. But I think
Speaker 3: the primary reason for why this cycle looks so different. Yeah, which,
Speaker 3: by the way, was the title of our Outlook report
Speaker 3: a year ago, this cycle is different.
Speaker 2: Is that a lot of how did you feel publishing that?
Speaker 2: Because I feel every time I say this time might
Speaker 2: be different, I get really nervous because like, there's going
Speaker 2: to be dozens, probably hundreds of people online who are like, eh,
Speaker 2: it's never different this time.
Speaker 3: But if you're not a little nervous, then you're probably
Speaker 3: not taking enough risky as a forecaster, because you're never
Speaker 3: going to be certain. So I felt that that was
Speaker 3: our core of you, and so I put it out
Speaker 3: there as the you know, as the title of the report.
Speaker 3: But of course there's always a risk that you're wrong
Speaker 3: about these things and end up with egg on your face.
Speaker 3: But what I was going to say is that I
Speaker 3: think the cycle is very different because, as you said
Speaker 3: in the opening part, the core dynamic of this cycle,
Speaker 3: really going back to the spring of twenty and twenty
Speaker 3: has been COVID and its aftermath and all the imbalance
Speaker 3: that emerged either directly because of the pandemic or because
Speaker 3: of policy responses. Then of course we've also had geopolitical shocks,
Speaker 3: the Russia Ukraine War in particular, But for me, it's
Speaker 3: really COVID and the recovery from COVID that makes this
Speaker 3: cycle soul different.
Speaker 2: So I mentioned the PSALM rule in the intro, and
Speaker 2: I think that's been getting a lot of attention recently
Speaker 2: because it's been getting closer to triggering. I think the
Speaker 2: rule itself is something like if the three month average
Speaker 2: of the unemployment rate this is U three is half
Speaker 2: a percentage point more or above it's low in the
Speaker 2: prior twelve months, then the economy is in the early
Speaker 2: stages of her session, and the current values something like
Speaker 2: point three to three something like that. I didn't realize
Speaker 2: that Goldman has a similar rule. Apparently it's a point
Speaker 2: three five percentage point increase again in the three month
Speaker 2: I think moving average of the U three unemployment rate.
Speaker 2: How much attention are you paying to your own rule
Speaker 2: in the current context of a softening labor market. Is
Speaker 2: it a similar idea to what Claudia was telling us
Speaker 2: that Again, maybe it's different this time it's just kind
Speaker 2: of chill.
Speaker 3: Yeah, there's different. There are different ways of characterizing the data.
Speaker 3: It's a you know, time series that goes back to
Speaker 3: the aftermath of World War Two. And it's certainly true,
Speaker 3: however exactly you want to define it, that significant increases
Speaker 3: in the unemployment rate have historically coincided with a recession
Speaker 3: in the in the United States. This is a historical fact.
Speaker 3: Now again, if this cycle is very different from past cycles,
Speaker 3: maybe that historical fact is not as relevant as it
Speaker 3: would be under other circumstances. I'd also note that we're
Speaker 3: only talking about you know, twelve or thirteen business cycles here,
Speaker 3: and it's not a huge sample. And lastly, I would say,
Speaker 3: if you go outside the United States, you also find
Speaker 3: that big increases in the unemployment rate have some predictive value.
Speaker 3: But the rule in quotation marks doesn't work as well
Speaker 3: as it does in the in the US. So when
Speaker 3: I take all of these things together, where do it
Speaker 3: come out. I would say significant changes in the unemployment
Speaker 3: rate is certainly something I would pay attention to, but
Speaker 3: I wouldn't, you know, elevate it to the status of
Speaker 3: something that tells you you now have to switch to
Speaker 3: a recession forecast if you know, if you do see
Speaker 3: a significant increase. I'd also note a few other things
Speaker 3: just about this particular episode. Other labor market indicators have
Speaker 3: continued to be, you know, pretty strong payroll growth over
Speaker 3: the six months in which the unemployment rate has been
Speaker 3: going up, as I think totaled one point two million
Speaker 3: or something on that order, The household survey employment numbers
Speaker 3: adjusted to the definitions of the payroll survey have shown
Speaker 3: a similar increase. Initial jobless claims remain quite low, not
Speaker 3: consistent really with a major layoff cycle. And so I
Speaker 3: take all of these things together, and I would say
Speaker 3: I'm still pretty comfortable that the labor market's doing fine.
Speaker 1: When would you be concerned? And I guess the reason
Speaker 1: I ask is partly because this might determine when the
Speaker 1: hiking cycle, which everyone basically thinks it, turns into a
Speaker 1: cutting cycle. At what point would you be concerned such that, Okay,
Speaker 1: the FED is going to need to move and maybe
Speaker 1: take out some insurance to forestall a deeper downtern I.
Speaker 3: Think it's always going to be a combination of indicator,
Speaker 3: so I don't think I would want to necessarily draw
Speaker 3: a line in the sand. But if we were to
Speaker 3: see much more pervasive signs of labor market deterioration with
Speaker 3: you know, jumps in initial claims and declines in payroll
Speaker 3: growth to something clearly below the replacement rate, so let's
Speaker 3: say in the fifty thousand range, or you know, moving
Speaker 3: closer to zero, and you get increases in the unemployment rate,
Speaker 3: that probably would be a reason to take out inshorance.
Speaker 3: And you know, it's not limited to those indicators, obviously,
Speaker 3: but if you got a combination of those indicators, I
Speaker 3: think it would be time to cut rates on the
Speaker 3: back of that. That doesn't happen in our forecast. Our
Speaker 3: forecast has payrolls still growing above one hundred thousand a month,
Speaker 3: and we have the unemployment rate going sort of broadly sideways,
Speaker 3: if not even a little bit lower over the next year.
Speaker 3: And in that kind of environment, I wouldn't expect early cuts.
Speaker 3: I think it'll still be a while before the FED
Speaker 3: does cut. But of course, one really important point now,
Speaker 3: and that's very different from a year ago, is that
Speaker 3: they can cut. They have the ability to respond to
Speaker 3: any weakening, foreseen or unforeseen by taking out insurance. And
Speaker 3: that's a really important reason for me why I think
Speaker 3: the risk of recession is significantly low than it was
Speaker 3: coming into this year. A year ago, we had a
Speaker 3: twelve month recession probability of thirty five percent. Now we
Speaker 3: have a twelve month recession probability of fifteen percent, and
Speaker 3: a lot of the delta is the fedsibility to respond
Speaker 3: to weakend numbers.
Speaker 2: I definitely want to ask you about more responses to
Speaker 2: slowing growth, including potentially on the fiscal side, but on
Speaker 2: the topic of the labor market. So one of the
Speaker 2: other things we've seen recently in terms of a slight
Speaker 2: softening of the data, has been job openings starting to
Speaker 2: come down. And on the one hand, people worry that
Speaker 2: this is a so that the economy is slowing. But
Speaker 2: on the other hand, this could be interpreted as sort
Speaker 2: of good news if you look back at the beverage
Speaker 2: curve debate and the idea that the relationship between unemployment
Speaker 2: and job openings had somehow structurally shifted during the pandemic.
Speaker 2: When you're looking at openings now, A, how much stock
Speaker 2: do you put in that data? First of all, because
Speaker 2: this is another big controversy, But b what are openings
Speaker 2: telling you right now?
Speaker 3: So I think it's very important to distinguish between good
Speaker 3: softening in the labor market and bad softening in the
Speaker 3: labor market. So the labor market was clearly out of balance, overheated.
Speaker 3: We had a job's workers gap job openings minus unemployed
Speaker 3: workers that was by far the highest level on record,
Speaker 3: a difference of six million, a ratio of something like
Speaker 3: two to one, and that clearly had to be addressed
Speaker 3: in order to be on a path to non inflationary
Speaker 3: growth and wage growth that's consistent with something like two
Speaker 3: percent inflation over time. So the decline and job openings
Speaker 3: that we've seen over the last year and a half
Speaker 3: or so, I think is very much a good thing
Speaker 3: because it puts us on a more sustainable footing. Where
Speaker 3: are we now. We've seen a drop in this job's
Speaker 3: workers gap from six million to about sort of two
Speaker 3: to three million, depending on which measure of job openings
Speaker 3: you use, and I would put some weight on the
Speaker 3: Jolts the official Libor Department data. I'd also put some
Speaker 3: weight on the link up data, some weight on the
Speaker 3: INDEED data, and that maybe answers the question about reliability
Speaker 3: a bit. I do think these indicators are challenging, and
Speaker 3: the Jolts series suffers from quite a low response rate
Speaker 3: and has been quite noisy, But if you combine it
Speaker 3: with other indicators, I would put some weight on it.
Speaker 3: I think it's telling us a broadly reasonable story that
Speaker 3: the labor market's still strong in terms of the amount
Speaker 3: of job openings out there, but it's less overheated and
Speaker 3: it's closer to normal, although still not back to where
Speaker 3: it was before the pandemic.
Speaker 2: You mentioned the response rate on the survey coming down,
Speaker 2: and that just reminded me of something else that sort
Speaker 2: of falls into this time might be different category, and
Speaker 2: that is that we have seen the response rates on
Speaker 2: a variety of economic surveys really come down quite dramatically
Speaker 2: in recent years, and there is this ongoing discussion of
Speaker 2: whether or not that might be clouding the economic picture. So,
Speaker 2: for instance, if you look at something like a consumer
Speaker 2: sentiment survey, you know, if these aren't the actual stats,
Speaker 2: I'm just making them up for illustrative purposes. But if
Speaker 2: fifty percent of those asked are now responding to the
Speaker 2: survey versus eighty percent ten years ago, you could imagine
Speaker 2: that maybe the people responding to the survey are you know,
Speaker 2: maybe they feel a little bit unrepresentative, unrepresentative, maybe they
Speaker 2: feel a little bit more strongly about certain aspects of
Speaker 2: the direction of the economy. Whatever is that on your radar,
Speaker 2: and are you taking that into account at all? Is
Speaker 2: it causing problems for economists at this point in time,
Speaker 2: or are you still sort of using a lot of
Speaker 2: the soft data, the survey based data, the same as
Speaker 2: you used to.
Speaker 3: I'd say you have to be aware of issues with
Speaker 3: economic data in a variety of areas. One thing that
Speaker 3: we actually have done over the last couple of years
Speaker 3: is probably putting more weight on hard data than on
Speaker 3: soft data. And we are i would say, pretty concerned
Speaker 3: about not just because of response rates, and things like that,
Speaker 3: but just for sentiment effect about the sentiment effects can
Speaker 3: sort of overstate a weakening of the economy. I think
Speaker 3: we've had a couple of instances in two thousand and
Speaker 3: twenty three when the sentiment based indicators deteriorated a lot,
Speaker 3: and then even within for example, business surveys, something like
Speaker 3: general business confidence was significantly weaker than questions that asked
Speaker 3: about orders or production or employment, which in turn was
Speaker 3: weaker than what the hard indicators were saying. And we
Speaker 3: have in those instances repeatedly put more weight on the
Speaker 3: hard indicators, and I think so far that's turned out
Speaker 3: to be the right choice.
Speaker 1: I'm going to go back to something you said in
Speaker 1: the first answer, which is that we have gotten this
Speaker 1: proof of concept of significant disinflation and relatively mild, if
Speaker 1: not nonexistent, labor market weakening, especially if you look across
Speaker 1: G ten countries. There has been some you know, obviously
Speaker 1: the unemployment rate in the US has tacked higher, but
Speaker 1: globally it's pretty remarkable. Does this tell us something about
Speaker 1: the degree to which economists understand the inflation process? Is
Speaker 1: there still more questions than as or do economists understand
Speaker 1: inflation except in weird business cycles that relate to pandemics.
Speaker 3: I think it is telling us that in this cycle
Speaker 3: there was a common global factor that has really dominated
Speaker 3: everything else, and that's COVID's that's my main takeaway. Obviously,
Speaker 3: there were quite a lot of differences in terms of
Speaker 3: policy responses across countries, and that has had its effect
Speaker 3: here and there. But the dominant issue that has faced
Speaker 3: the global economy over the last you know, three and
Speaker 3: a half to four years has been COVID and the
Speaker 3: recovery from COVID and betting on effectively convergence between different places,
Speaker 3: you know, in terms of the inflation experience, I think
Speaker 3: has been the right approach so far. I'll give you
Speaker 3: an example. The European both your area and UK inflation
Speaker 3: data until recently looked significantly higher than what we were
Speaker 3: seeing in the US and Canada and maybe some of
Speaker 3: the em countries, and what I just outlined suggested we
Speaker 3: really should be putting weight on convergence, and indeed both
Speaker 3: the UK and Europe is now seeing significantly friendly inflation numbers.
Speaker 2: I want to press on this point because again, up
Speaker 2: until recently, when inflation really did start coming down in Europe,
Speaker 2: and the UK. There was an argument out there that like,
Speaker 2: maybe the US had outperformed because of the fiscal response
Speaker 2: in twenty twenty and beyond, which was absolutely massive on
Speaker 2: a sort of relative historic basis. How much weight do
Speaker 2: you place on the fiscal aspect of this at this
Speaker 2: moment in time, And then also going into twenty twenty four,
Speaker 2: there is this open question about whether or not the
Speaker 2: US will have the same fiscal capacity to keep on
Speaker 2: spending or maybe do some sort of emergency stimulus if needed.
Speaker 2: So how are you thinking about that aspect of it?
Speaker 2: Beyond the monetary side of things.
Speaker 3: I think there are a lot of separate questions here.
Speaker 3: One is the size of the US fiscal response and
Speaker 3: then the impact of that on twenty twenty twenty twenty
Speaker 3: one GDP. Clearly the US did a lot and that
Speaker 3: did have a significant impact on growth at that point.
Speaker 3: I mean, there was a huge fiscal boost in that
Speaker 3: supported activity, and you know, I think it was very important.
Speaker 3: Then it's been much less important from a growth perspective
Speaker 3: since then. I mean twenty twenty two there was a
Speaker 3: fiscal pullback which consumers were able to spend through in
Speaker 3: part because of a lot of the excess savings twenty
Speaker 3: twenty three, we actually don't get a significant fiscal impulse,
Speaker 3: and by fiscal impulse, I really mean basically the change
Speaker 3: in the deficit and the growth relevant changes in fiscal policy.
Speaker 3: We don't get a big impact here in twenty twenty three.
Speaker 3: It's certainly true that the US federal deficit is very
Speaker 3: large six to seven percent of GDP depending on how
Speaker 3: you adjust for some of the one off items. But
Speaker 3: it's a very large number, especially relative to a three
Speaker 3: point nine percent unemployment rate. This is a very different
Speaker 3: deficit from the deficit that we had in the aftermath
Speaker 3: of the two thousand and eight crisis, when we also
Speaker 3: had a large deficit, but it was the flip side
Speaker 3: of a depressed economy. And so this is more concerning
Speaker 3: because it's a structural deficit that will need to be
Speaker 3: addressed over time. I wouldn't expect it to get addressed
Speaker 3: anytime soon. I mean, twenty twenty four is a presidential
Speaker 3: election year, very little is likely to happen on fiscal policy,
Speaker 3: and even beyond that, the path to how we're ultimately
Speaker 3: going to address this is not clear.
Speaker 1: In September, and I guess the first half of October
Speaker 1: when rates were galloping higher. Suddenly one of the big
Speaker 1: themes people were talking about was not just the size
Speaker 1: of the deficit, but the size of the interest payments
Speaker 1: on the deficit, arguably the inflationary impulse of those interest
Speaker 1: payments in the sense that those interest payments are a
Speaker 1: fiscal outlay, and then this idea of a snowball and
Speaker 1: compounding effect of large deficits. When you say you're concerned,
Speaker 1: or when you say it is concerning, or at some
Speaker 1: point would we need to address, what does that look
Speaker 1: like for you in terms of the problems that arise
Speaker 1: if politicians don't do something to close the structural deficit,
Speaker 1: And what would be the point at which it becomes
Speaker 1: a major problem for the economy if interest payments as
Speaker 1: a share of GDP start to become very large.
Speaker 3: I think it's hard to have a very crisp answer
Speaker 3: to that, and I don't think we're close to a
Speaker 3: crisis point. I think over time, though, if the deficit
Speaker 3: continues to be as large as it is now or
Speaker 3: rise from here, maybe on the back of increases in
Speaker 3: interest payments as the dead stock gets rolled over, that
Speaker 3: is going to crowd out other types of outlays in
Speaker 3: the in the economy. It's clearly going to be an
Speaker 3: issue for the federal budget itself, and in may, if
Speaker 3: we're in a broadly full employment environment, may also crowd out,
Speaker 3: you know, other types of private sector investments in the
Speaker 3: in the economy. Crowding out is a you know, long
Speaker 3: debate in economics and.
Speaker 1: What does it mean to you?
Speaker 2: Would you say it?
Speaker 1: Yeah, like, what is it?
Speaker 3: It basically means that federal deficits squeeze private sector investment.
Speaker 3: There was a big debate about this again in the
Speaker 3: aftermath of the two thousand and eight crisis. I was
Speaker 3: on the other side of that debate at the time
Speaker 3: because we had an clearly underemployed economy. We were away
Speaker 3: from the full employment level of output, and so there
Speaker 3: was no taking away from private sector expenditure because of
Speaker 3: fiscal deficits. But we're in a if we're going to
Speaker 3: be in a full employment economy, then I think it's
Speaker 3: going to be more of an issue.
Speaker 2: Speaking of spending, this is a very clumsy segue the consumer.
Speaker 2: We haven't really dived into what's been going on with
Speaker 2: the consumer, but of course, if you look at the
Speaker 2: surprising resilience of the US economy, A lot of it
Speaker 2: seems to have been underpinned by consumer spending. So what's
Speaker 2: been driving that going into twenty twenty three, and then
Speaker 2: also what's the outlook because again going back to the
Speaker 2: soft data, you look at survey after survey and certainly
Speaker 2: spending time online and on Twitter slash x, you do
Speaker 2: get the sense that people are struggling with inflame. And
Speaker 2: yet if you look at the hard data, the actual
Speaker 2: consumer spending number, I mean, it just keeps going.
Speaker 3: So twenty twenty two you had a huge decline in
Speaker 3: real disposable personal income because of this inflation spike and
Speaker 3: the end of the COVID support payments. So real disposable
Speaker 3: income was down something like six percent, biggest decline in
Speaker 3: post war history, much bigger than an eight or nine.
Speaker 3: But households were able to spend through it because of
Speaker 3: the stock of excess savings. So that stock of excess
Speaker 3: savings has now diminished, and there's a lot of concern
Speaker 3: what happens when people run out of excess savings, what's
Speaker 3: going to support their spending. The answer is that real
Speaker 3: income is now growing, and it's growing at a very
Speaker 3: healthy pace. Twenty twenty three about four percent growth in
Speaker 3: real disposable income, as wages are still growing at a
Speaker 3: decent pace four to four and a half percent headline
Speaker 3: inflation has come back down to the law threes, so
Speaker 3: real wages are now going up. Employment is still growing
Speaker 3: at a healthy pace. Interest income is rising, while on
Speaker 3: the other side of the balance sheet, mortgage interest paid
Speaker 3: is barely rising because most people have thirty year fixed
Speaker 3: rate mortgages. That's really the driver of continued increases in
Speaker 3: consumer spending, and I think we'll see something similar next year.
Speaker 3: Maybe not four percent for disposable income, maybe three or
Speaker 3: a little bit low three, but still enough to keep
Speaker 3: consumer spending growing in real terms at something like a
Speaker 3: two percent rate.
Speaker 1: One of the things that's a recurring theme on the
Speaker 1: show that we talk about a lot is this sort
Speaker 1: of acyclical investment, the green transition, all of the IRA spending,
Speaker 1: the tax credits, the various incentive new battery plant. Seemingly
Speaker 1: every day it seems like twenty twenty four is going
Speaker 1: to be another big year for a lot of sort
Speaker 1: of government incentivized domestic manufacturing. Of course, you have chips,
Speaker 1: you have vvs, you have batteries. You have investments on
Speaker 1: tackling domestic sources of raw materials for batteries and so forth.
Speaker 1: How much does that boy the US economy keep a
Speaker 1: floor under activity? And how are you thinking the sort
Speaker 1: of macro impact from some of these large pieces of legislation.
Speaker 3: So the numbers end up being relatively small if you
Speaker 3: divide it by twenty seven trillion dollars, that being US
Speaker 3: nominal GDP. So I think these are very important developments
Speaker 3: in particular parts of the economy. Obviously in the clean
Speaker 3: energy sector. They're very important from a growth perspective. I
Speaker 3: don't think that's where the action has been even with this.
Speaker 3: We don't think that there's been a large, meaningful booths
Speaker 3: to growth in twenty twenty three from fiscal changes. Actually,
Speaker 3: the investments next year probably going to be a little
Speaker 3: bit smaller than in twenty twenty three, just looking at
Speaker 3: some of the bottom up project data. But yeah, it's
Speaker 3: this is still there's still a high investment level in
Speaker 3: that part of the economy. It's very important for certain
Speaker 3: parts of the economy and from a climate perspective and
Speaker 3: clean energy perspective, but it's not a major macro issue.
Speaker 1: One other big macro dynamic that I don't know. It
Speaker 1: seems like it's in the realm of interesting or people
Speaker 1: are paying attention to it but not sure quite what yet.
Speaker 1: To make of it is that we've gotten some good
Speaker 1: productivity readings lately, and there's all these questions about, you know,
Speaker 1: a how do you measure productivity? Because it's just sort
Speaker 1: of a Tracy's telling me over I read that I
Speaker 1: stole her question.
Speaker 2: Joe asked for a follow up and then went to
Speaker 2: a completely different talk. Kind of no, but that's fair. Look,
Speaker 2: we're recording this on November twenty first. Open AI has
Speaker 2: been in the news, and certainly the idea of AI
Speaker 2: and productivity the boosts have been in a lot of
Speaker 2: analyst research notes.
Speaker 1: Exactly so, how much of productivity is, in your view,
Speaker 1: something exogenous, a tech breakthrough that allows work to be
Speaker 1: done more productive? How much is it about Okay, this
Speaker 1: is just what happens in this stage of the cycle.
Speaker 1: Could it be a reverse historicis effect, in which when
Speaker 1: you have periods of very intense high unemployment then companies
Speaker 1: have to find ways to improve productivity. Other theories is
Speaker 1: that it's actually a function of the employment mix and
Speaker 1: that if you have more people working in factories, etc.
Speaker 1: Then you're going to have higher productivity growth than if
Speaker 1: you have more people working in daycares and healthcare centers,
Speaker 1: where it's hard to achieve productivity. What do you make
Speaker 1: of the gains and what do you think are the
Speaker 1: prospects for something like this being sustained.
Speaker 3: The main thing is that the productivity data are always noisy,
Speaker 3: and have been incredibly noisy in the last three and
Speaker 3: a half or four years. So I like to look
Speaker 3: at things over a somewhat longer time horizons, and in particular,
Speaker 3: what's the question, what's happened since the fourth quarter of
Speaker 3: twenty nineteen, And the latest numbers are showing just under
Speaker 3: one and a half percent annualized growth in non farm
Speaker 3: business labor productivity, which is a little bit better than
Speaker 3: what we saw in the five or ten years before
Speaker 3: the pandemic, but not by a lot. It's a few tents,
Speaker 3: and I think that's probably a reasonable starting point of
Speaker 3: where we are from a productivity growth perspective. We do
Speaker 3: expect a boost from AI to productivity growth, but probably
Speaker 3: not for a number of years. I don't think. In fact,
Speaker 3: I'm pretty certain that we're not seeing that right now,
Speaker 3: and I wouldn't really expect it over the next couple
Speaker 3: of years. Maybe late in the decade, we can see
Speaker 3: a lift there, and I think it could be sizable,
Speaker 3: but I don't think that that's what we're looking at
Speaker 3: at the moment, Joe.
Speaker 2: I just had a flashback. You know. One of the
Speaker 2: first pieces you ever commissioned for me when we started
Speaker 2: working together at Bloomberg was actually one of Yan's notes
Speaker 2: on productivity and how if you look at video games
Speaker 2: like Grand Theft Auto. I don't know if you remember this, Yeah,
Speaker 2: like the video games have gotten yes, yeah, so terrible times. No, anyway,
Speaker 2: that was just a random walk down memory lane. But
Speaker 2: just on this topic of AI, you know, one of
Speaker 2: the themes running through this conversation has sort of been
Speaker 2: it's different this time and in addition to things like
Speaker 2: AI and chat GPT, we've had the supply side factors
Speaker 2: that we've been discussing the role in inflation and things
Speaker 2: like that. It feels like the economics profession has had
Speaker 2: to deal with like these brand new sort of topics
Speaker 2: or themes running through the macro picture from AI to
Speaker 2: supply side. How do you go about incorporating these new
Speaker 2: things into your research and your forecast, because I can't
Speaker 2: imagine that, you know, pre twenty twenty you were an expert.
Speaker 2: I mean, please tell me if this is wrong, but
Speaker 2: you were an expert on logistics or shipping or things
Speaker 2: like that. The same goes for us, by the way.
Speaker 3: Yeah, we've had to pick up an unusually large number
Speaker 3: of new things over the last several years. I mean,
Speaker 3: there's always some of that, because the most interesting things
Speaker 3: that happen in the economy are often not once that
Speaker 3: you can just look up a in a textbook. But
Speaker 3: it's been definitely sort of an overload of new things
Speaker 3: to get smart on and be able to assess. And
Speaker 3: AI is a great example of that. You know, the
Speaker 3: supply chain disruptions. The virus obviously is maybe the canonical
Speaker 3: example of something that you know, most of us had
Speaker 3: no idea about and then had to get at least
Speaker 3: somewhat familiar with. You know, I'd say you have to
Speaker 3: be eclectic in terms of what kind of information you're
Speaker 3: going to draw on. If I take AI for example,
Speaker 3: we've spent quite a lot of time looking at occupational
Speaker 3: classifications that the US labor Department or the European Union
Speaker 3: put together that break down the labor market into in
Speaker 3: the case of the US Labor Department, nine hundred occupations
Speaker 3: and then provide a pretty detailed accounting of what tasks
Speaker 3: workers in each of these occupations fulfill in order to
Speaker 3: be able to assess, you know, what part of this
Speaker 3: could be replaced by AI. So it's pretty detailed quantitative work,
Speaker 3: although there's obviously a large speculative component to it because
Speaker 3: we're making informed guesses of what could be replaced. We
Speaker 3: don't know how powerful AI is going to be ultimately,
Speaker 3: but that's the sort of analysis that we've had to
Speaker 3: do in other contexts a number of times, especially in
Speaker 3: recent years.
Speaker 2: Didn't you start looking at I can't remember the name
Speaker 2: of it, but that layoffs, the layoff filings, the ones
Speaker 2: that if companies are.
Speaker 3: Like the war notices, Yeah, that's it.
Speaker 2: Didn't you build an indicator for that?
Speaker 3: Yes?
Speaker 2: So what is that telling you now? Because again, in
Speaker 2: twenty twenty two, that was a big year for mass layoffs,
Speaker 2: especially in the tech industry. But maybe some of those
Speaker 2: big on mass layoffs have sort of eased a bit.
Speaker 3: Yeah, it's not telling us anything very different from other
Speaker 3: more conventional data sets like initial jobless claims or the
Speaker 3: jolt's layoff rate. And I also would say this one
Speaker 3: is a little bit closer to the beaten path. It's
Speaker 3: been around for a while, and we're obviously trying to
Speaker 3: measure something that is very core to any economic model.
Speaker 3: But yeah, it's definitely been a helpful indicator that has
Speaker 3: generally sort of told a slightly more reassuring story and
Speaker 3: continues to do so.
Speaker 1: So we just have a few minutes left. Let's talk
Speaker 1: a little bit more about twenty twenty four. I think
Speaker 1: you said right now your odds of recession are teen
Speaker 1: percent in the next fule month.
Speaker 3: That's right.
Speaker 1: You do see cuts on the horizon, just not imminately.
Speaker 1: Talk to us a little bit about how you see
Speaker 1: the next twelve months unfolding.
Speaker 3: Yeah, we have, I would say, on the growth side,
Speaker 3: more of the same twoish percent growth I mean annual average.
Speaker 3: You know, we're two point one percent at the moment,
Speaker 3: which is a little bit below where twenty twenty three
Speaker 3: is probably going to come out. So call that broadly
Speaker 3: trend growth with the unemployment rate going sideways to you know,
Speaker 3: maybe a touch lore. We have inflation still coming down
Speaker 3: from you know, certainly on a year on year basis
Speaker 3: coming down. We have core PC inflation in the fourth
Speaker 3: quarter of next year at you know, two point four percent,
Speaker 3: so still above the official target, but within the zone
Speaker 3: that I think would be pretty comfortable for FED officials
Speaker 3: in that kind of baseline scenario. I don't think that
Speaker 3: the FED is going to be in any hurry to cut,
Speaker 3: so we don't have cut until the fourth quarter of
Speaker 3: next year. The risks to that baseline path for the
Speaker 3: funds RAID though, are strongly on the downside. It's very
Speaker 3: unlikely that we're going to see a significant amount of
Speaker 3: additional hikes, but it's very possible that we'll see cuts
Speaker 3: if there is, you know, more of an air pocket
Speaker 3: in growth than what we have in our forecast. And
Speaker 3: I certainly would if I put myself in the shoes
Speaker 3: of FED officials faced with a significant air pocket that
Speaker 3: looks like a bigger risk of recession, I'd certainly be
Speaker 3: very comfortable in cutting. In response to that.
Speaker 2: You know, I tried to ask Michael Barr from the
Speaker 2: FED this question and was completely unsuccessful recently. But in
Speaker 2: terms of a slowdown in US growth or a recession indicator.
Speaker 2: If you had to choose one thing to look at,
Speaker 2: you know, you're stranded on a desert island and you
Speaker 2: can only look up one chart on your Bloomberg terminal,
Speaker 2: what would it be at this point?
Speaker 3: It would be a labor market indicator. I mean initial
Speaker 3: claims is I think a very traditional one. The unemployment
Speaker 3: rate would obviously receive quite a lot of weight. The
Speaker 3: payroll numbers, I mean, that's usually what tells you that
Speaker 3: a recession really has started. GDP is obviously heavily revised
Speaker 3: and can be quite noisy, especially after a four point
Speaker 3: nine percent number in Q three. If you had a
Speaker 3: weaker number, you might want to average that. But if
Speaker 3: you have material deterioration in the labor market, something much
Speaker 3: more material than what we've seen so far, which I
Speaker 3: think is still very debatable, then that would obviously be
Speaker 3: an alarm sign.
Speaker 1: Jan Hatzius, chief economist at Goldman Sex, thank you so
Speaker 1: much for coming back on outlage.
Speaker 3: That was great, great to be with you. Thanks.
Speaker 1: You know what point I really like Tracy. First of all,
Speaker 1: obviously I really enjoy talking to Yan every time a
Speaker 1: point that he made, and I guess I think It's
Speaker 1: also kind of a point that Austin Gorle has been
Speaker 1: made when we talked about, like economists talk about all
Speaker 1: these historical patterns, there are so few examples of all this.
Speaker 1: It sort of makes a mockery of the idea of
Speaker 1: statistical significance. The idea is like, oh, we're going to
Speaker 1: build these rules on thirteen events or four events. It
Speaker 1: always sort of blows my mind that people take that
Speaker 1: too seriously.
Speaker 2: Well, how many business cycles was it that Yan mentioned,
Speaker 2: like twelve something like that. I can't remember this specific number,
Speaker 2: but you're right, it's a pretty small sample. On the
Speaker 2: one hand, I can understand the allure of having a
Speaker 2: sort of hard rule that's grounded in I don't mean
Speaker 2: simple in a pejorative sense, but in a simple rule.
Speaker 2: You know, if the moving average of the unemployment rate
Speaker 2: is above this, then like it's time to watch out.
Speaker 2: That's intrinsically attractive, and you can see why people would
Speaker 2: gravitate towards that. But on the other hand, I do
Speaker 2: take the point that in a business cycle that has
Speaker 2: been so unusual, you should be allowed to make sort
Speaker 2: of qualitative judgments on what's happening with the sort of
Speaker 2: hard data.
Speaker 1: Yeah, I think that's spot on, right. The key thing
Speaker 1: is like some humility because A you don't have a
Speaker 1: ton of examples, and B this is a very weird example.
Speaker 1: It's just really was not Twenty twenty was not a
Speaker 1: normal recession. The policy response was not normal, the shift
Speaker 1: of consumption from services to goods was not normal. There
Speaker 1: were many very weird things that happened over the last
Speaker 1: three years. And so yeah, the idea that these rules
Speaker 1: that are formed based on a limited number of historical
Speaker 1: examples to apply to a situation that is not now
Speaker 1: seems like a very good reason for general humility. But
Speaker 1: as he points out, you look at the scoreboard all
Speaker 1: around the world and it's really not just US. We've
Speaker 1: seen this decline in inflation without much labor market weakness.
Speaker 1: It is possible.
Speaker 2: Yeah, and that's really interesting because again, like the explanation
Speaker 2: for it just six months ago was fiscal response from
Speaker 2: the US, and now maybe that's not so much. The
Speaker 2: case of inflation is coming down everywhere. You know what
Speaker 2: I was thinking when you were sort of listing all
Speaker 2: those one off events, it'd be really interesting to compile
Speaker 2: like all the things that are sort of unusual about
Speaker 2: this cycle because there are also less obvious ones. I mean, yeah,
Speaker 2: touched on some of them. But the idea that the
Speaker 2: majority of homeowners now have lost in those thirty year rates,
Speaker 2: so the pass through from higher benchmark rates just isn't there.
Speaker 2: Like that seems kind of unusual. There's so many that
Speaker 2: you could actually go through. The change in like survey
Speaker 2: responses would be an interesting one. So obviously the stuff
Speaker 2: we've seen on the supply side, I mean there dozens.
Speaker 1: It really is different this time you said it.
Speaker 2: It makes me so nervous whenever anyone says that, I
Speaker 2: feel like we're just a teching shade. Yeah really, but okay,
Speaker 2: on that note, shall we leave it there?
Speaker 1: Let's leave it there.
Speaker 3: Okay.
Speaker 2: This has been another episode of the Odd Thoughts podcast.
Speaker 2: I'm tre you can follow me at Tracy Alloway.
Speaker 1: And I'm Joe Wisenthal. You can follow me at The Stalwart.
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