Moody's Talks - Inside Economics - Banner Inflation, Banking Braves Out

Episode Date: August 11, 2023

The Inside Economics team dissects the July report on consumer price inflation and concludes that inflation is on track to be back to the Fed’s inflation target by this time next year. Well, OK, Cris thought more likely the end of next year. The discussion then turned to modest fallout from the banking crisis earlier this year (at least so far) and Fed policy with University of Maryland economics professor Sebnem Kalemli-Ozcan.For more from Sebnem Kalemli-Ozcan, click hereFor the full transcript, click hereFollow Mark Zandi @MarkZandi, Cris deRitis @MiddleWayEcon, and Marisa DiNatale on LinkedIn for additional insight. Questions or Comments, please email us at [e-mail]. We would love to hear from you.  To stay informed and follow the insights of Moody's Analytics economists, visit Economic View. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to Inside Economics. I'm Mark Zandi, the chief economist of Moody's Analytics, and I'm joined by a few of my colleagues. I've got Chris, Chris, Chris DeRidis. Hey, Chris. Hey, Mark. How you doing? Doing well. I ask you that every week. And you tell me I'm doing well. That's good. Yeah, let's hope I continue. I know, I'm well for that. We're doing well. And we've got Marissa. Marissa's, were you here like, you know, you were AWOL. No, I was, yeah, I've been vacationing, Mark. Sorry about that. No, no, that's fair enough. I know you were in Hawaii. I mean, boy, what a mess. I know. I know. I wasn't on Maui, but it's, it's really sad. You know, the funny thing is I was there this time last year. Yeah. A little less than a year ago, Lahani, and I'll have to say, I'm pronouncing that wrong, but the town that got destroyed. And they had this restaurant called the Lahani Grill. And I'm, I don't, I'm not exaggerating. It may have been the, best meal I've ever had in my life. It was so good. It was just so good. It's such a shame. I feel so bad for those folks. I mean, what a tough, tough thing. It's really tough. And we got Bernard, Bernard, Geros. Bernard, good to have you. You become a regular, particularly when we've got the inflation numbers. This is the week for inflation, statistics CPI and PPI, so a lot to talk about.

They're good to have you on. Thank you. You look like you're in a 1950s movie, though. I don't know. What's that all about? There's no color. I mean, what's going on? I'm in, you know, the lighting in the room that I'm in is kind of weird. And then I've got the loom cube. So I don't know what effect. Oh, yeah.

You look like you're in an Alfred Hitchcock movie or something. You know, the birds, you know? There you go. We lost Chris for a moment, but I'm sure he'll be back. Hey, so the CPI, PPI, you want to give us the rundown? on the on those statistics this week of course yeah so the july consumer price index i would say was good news all around and just for our listeners the cpi measures the average change in prices that are paid by consumers for a given basket of goods and services and in july the overall

cpi rose 0.2 percent and the core cpi which economists like to look at because it strips out volatile food energy prices, that also rose by 0.2%. Both of these growth rates were in line with R and consensus expectations. So there was absolutely no surprise here whatsoever. And while we should feel good about the July CPI, there are some upside risks to the CPI that are lurking out there in the near term and that are tempering a bit of the optimism that I would otherwise be feeling And right now, I guess my biggest future concerned are in energy and food prices. So for the month of July, gasoline prices were really only a minor support to the CPI. They were up only two-tenths of a percent.

However, in August, gasoline prices are rising. The national average of regular unleaded gasoline is 30 cents higher than it was a month ago. And also, if we look at wholesale gasoline futures, which typically lead retail gasoline prices by about two weeks. They're also on the rise and suggest that retail gasoline prices are going to head higher throughout the rest of August. So that suggests that we're going to get a bigger contribution to the CPI from gasoline in August than we did last month. And also, elsewhere, within energy, the price of energy services. So think electricity, utility gas services, those fell by, those prices fell by 0.1% in July. But also natural gas price.

prices have risen to a six-month high in August, and if that continues, that's also going to show up to a greater degree within the CPI for energy services moving forward. There's spillover effects from energy into the other most important essential good that we, you know, whose prices we interact with, you know, on a weekly basis, and that's for food. So last month, the CPI for food increased by 0.2%. It wasn't, you know, really a big, surprise. I think one, one interesting development was that the CPI for food away from home, so this would be the prices you pay at a restaurant. That, the CPI for the food away from home rose at its slowest pace, you know, rose at its slowest pace since March 2021. And this is probably just because wage growth in the food services industry has been relenting meaningfully in recent months, and it's no longer putting as much upper pressure on the menu prices that consumers are seeing at the restaurant.

So while this was a good surprise, I think we are due for an unwelcome upside surprise in food prices in the not so distant future. And that's just because you look at, again, another energy price. If you look at the spot price for diesel, that has risen sharply in recent weeks to its highest level since early February, late January. and diesel is the absolute workhorse fuel of the agricultural industry. We use it to power the farm equipment to pump irrigation water and to transport farm produce. So diesel prices typically lead grocery store prices or what we would like to call the CPI for food at home by a few months.

So if we get further increases in diesel prices, I'm concerned that that's going to push up on food prices. So I'll stop there. I mean, it seems like you're going to the negative, almost, I mean, right away without even talking about the positive. I mean, I'm just, I'm just looking ahead. There's stuff that's, yeah, yeah, yeah. Come on. I mean, that CPI report was great, wasn't it?

It was great. Okay, come on. Let's just dwell on that. He led with that, Mark. Huh? He did, I guess, for like five seconds. And then he's off and running about oil prices and food prices. Everything's going up.

I mean, come on. Come on. All right. Come on. Let's just take a step. And by the way, we lost Chris DeReedies. I don't know what happened to Chris. Hopefully he finds his way back, you know, to the podcast.

But I know we've been having all kinds of power outages, you know, here. I know because we had a terrible storm. So here he's coming back in. And, you know, I think he lost internet connectivity for a while. So that may be part of it. Okay. Bernard. Okay.

Tell me. Tell me, I mean, what's the fundamental point here, though? The fundamental point is what? Inflation is coming down. Yeah. Okay. Yeah. Yeah.

All right. Okay. And why is it coming down? Well, a lot of the, so if we're just looking at, again, if we're looking year-over-year trend growth in the overall CPI, that's come down from little under 9%, you know, almost a year ago. and it's now at about, you know, just a little over 3%. So there's been a lot of moderation in inflation. And as you, and as we will talk later in the podcast, we've gone this moderation and inflation

without a significant rise in unemployment or a significant deterioration of labor market. So we've, you know, we've really been able to achieve a lot less inflation without worse, you know, outcomes in the real economy. Yeah, and I should have said up front because you alluded to it just now, just so the listener knows.

We've got another guest. Someone from Mount Sibnem, Kalimi as can, and she's a professor of finance economics at the University of Maryland. She's going to be joining us a little bit later in the conversation, and we've already recorded that part of the conversation. So that's what you were alluding to. Yeah. We lost Chris again.

I mean, I know what's going on. But, okay, so broadly speaking, it feels like inflation is moving in the right direction here. And when you look at the components, and abstracting from, you know, a lot of that year-over-year improvement in inflation is energy, the decline in energy prices compared to a year ago. As you pointed out, they are starting to rise again. And that's looking to, you know, to the future reports that we're going to see here. But, but even abstracting from the energy prices, we're seeing, you know, a broad-based moderation. Exactly. Yeah. And, you know, can, do you have a sense of, I'm going to ask one more time, and then I'm going to turn to Merristen, get her sense of it. Fundamentally, what's driving this moderation and inflation.

If it's not, you know, unemployment hasn't risen. You know, it's not like the economy's growth rate is. It's moderated with the Fed rate exit, but it's still pretty solid growth rates. I mean, we're still getting solid job growth and GDP in the first half of this year was close to 2%. which is close to the economy's potential. So what's going on here? What's driving this fundamentally? I would say it's fundamentally.

It's the unwinding of a lot of pandemic-induced supply chain stress. So that's showing up in core goods prices. And then it's also the fact that shelter prices, so the cost of housing for renters and then homeowner, you know, the hypothetical rent that homeowners would pay. So that's owners equivalent of rent. that has also come, that has peaked and is starting to come down. And we're expecting that to really come down further. So I would say these are the two key elements that have allowed us to achieve this disinflation without worse labor market outcomes.

Got it, got it. And Mirza, so what do you think? Is that? That's the correct answer. Yeah. It is the unwinding of everything that's happened over the past two years with the pandemic and the Russian invasion of Ukraine, further exacerbating supply chains that were already mucked up during the pandemic, right? So it's just all of that coming back down to Earth. Right. Okay. Now, the other alternative explanation is demand side push, you know, the fiscal stimulus provided by the American Rescue Plan back, well, over two years ago now. What do you think? Is that playing a role here or not so maybe on the margin? How big a deal is that or or not?

That was more of an issue. That was more of a role that played more of a role last year, whereas this year it's not as much. Yeah. It's hard to connect those dots. Yeah. Over now almost two and a half years after the fact. Exactly.

Yeah. Because that was passed in March of 21, that piece of legislation. Exactly. Okay. I think that that staved off a more, a deeper downturn than we would have had, you know, had that not passed. But I think at this point, middle income, low income households have likely blown through all of the excess saving that they had during the pandemic and including stimulus money that they got. So now we're really seeing the impact of, you know, stripping that out, right? Right, right. I'm sorry. I'm a little distrapping.

because Chris keeps coming in and out. Popping in and out. He's popping in and out. And he's trying different things. You can tell. You know, he's trying different things to get into the podcast. So I think he was on his phone than the last time.

Okay. So let's go back, Bernard, to your rundown. And let's just explore that a little bit more. So what you were, what you quickly got to was, look, yes, we've had all this great inflation news.

But it doesn't feel, It feels like it's going to get a lot harder to get inflation back all the way down here. So inflation is sitting in terms of CPI consumer price index. It feels like it's top lines around three. The core is still higher than that, still four and a half to five. And to get it all the way back into something we all feel comfortable with, certainly consistent with the Fed's target for which for consumer price inflation is probably about two and a half percent. That's going to be more difficult.

And one of the reasons for that is this recent run. up in all prices. Exactly, yes. Yeah. It's a concern. I mean, I think for now it's not, it's a yellow flag. It's not, I don't think we're, it's not, not something I'm too concerned about, but it's, okay.

It's moving in the wrong direction. Yeah. Because it with oil now is sitting somewhere between 80 and 85 bucks a barrel, depending on WTI or Brent. That's probably consistent with, what, $4 for a gallon of regular unleaded, maybe a little higher than that, something like that. Is that right? And that is well above where we were last month.

And certainly I think the low was $3.25, $3.50, something like that, not too long ago. So that's going to add directly to top line inflation next month when we get the next month for month of August next month. And then you're also making the point, well, this is also going to be an issue for food prices because diesel has gone up. and diesel's key to the cost of food. Exactly. Okay, fine. But you're saying if we stay at 85 bucks a barrel, this is great for the near term, but it doesn't derail this steady moderation and inflation.

Yeah, yeah, exactly, yeah. Okay. All right, let me ask you another question, a negative and positive. On the negative side, is there any other price out there that you're worried about, any other, you know, commodity or service for which you're fearful that that's going to pick up and make it more difficult for get inflation back in the bottle? So the next risk I see out there, and this is probably going to be a podcast in September, is what's going on with the United Auto Worker Strike against the Big Three U.S.

Automakers, Ford, Stalantis, and GM. In July, new vehicle prices fell by 0.1%. And this was expected in our bottom-up CPI forecast. We expected a decline of this magnitude. And this was expected because we have had a welcome spike in U.S. auto assemblies, especially during the second quarter. In April of May of this year, U.S. auto assemblies rose to a level that was even higher than its average for all of 2019, which was well before we had all.

of these pandemic-related supply chain disruptions. But if we do get a work stop-it, if the negotiations between the UAW with the big automakers, if that fails and it ends in a work stoppage sometime in mid-September, there just isn't enough inventory to really keep prices from rising. Because that's going to affect auto production, which empirically we do see that that does have some in effect. on prices with like a two to three month lag.

And it's important to remember that last time we had a UAW strike, I think it was back in 2019. We really didn't see that many major macroeconomic consequences, but that's just because the strike affected only one automaker, not three, which could be the case this time. And we also weren't being impacted by reduced auto inventories, as is also the case now. So that's just one concern. But whatever upside we get to new vehicle prices maybe in the fall or winter because of any potential strike, I think that should still be largely offset by the enormous disinflation or the enormous deflation that we will see month over month in used vehicle prices, which fell 1.3% in July. And that we should continue to see further declines in used vehicle prices just based on what. what we're seeing in auctions, dealerships are just paying much less than they were before

for the used vehicles that they then sell later to consumers. Okay, so what you're saying is another threat to getting inflation back in the bottle is new vehicle prices, particularly the UAW strikes and strikes against all the automakers, but that should be offset in part or in whole by continued declines and used vehicle prices. Is that what you're saying? Yeah, yes. At least through the early. full, I would say.

Yeah. And of course, these things will, should, presumably, if there is a strike, it isn't going to go on for a length, well, it could be a few months, but that,

probably not longer than that. So this may be an issue for the second half of this year, but as you make your way into 20, 24, not so, it's just the opposite. Yeah, exactly.

Okay. All right. It's not great, though. Hey, Marissa, and Bernard, I kind of come back and ask you,

If there's any other components out there that make you more optimistic about inflation going forward. But before I do that, I'm going to turn to you, Marissa. Any component of the consumer price index, commodity or service that you're worried might add to inflationary pressures going forward? And you don't need to come up. No, no, I'm not. But I'm just asking. No, I think, and I think even if we do inevitably see an increase in headline CPI because of energy, prices, I think that the Fed will look through that. And I think they're really focused on core

inflation. And in the July CPI report, it's really, shelter is the key to really most of that, right? That accounted for 90% of the increase in core services over the month of July. So it's really hinging on what's going on with the housing market here, both owner's equivalent rent and rent of shelter. Yeah. Okay. So I'm really keyed in on that. Yeah, I'm sorry. I'm kind of chuckling because I see Chris. Chris is resorting to community. He's got a little hand up. We're obviously in Zoom. And so you've got a little hand up. Hey, Chris, and I know what you're going to say, because you've got, I know it. But go ahead. Go ahead. Tell everybody what you're worried about. Well, Mark, have you been to the doctor lately?

I knew he was going to say that. I knew he was going to say that. He didn't say that I was going to say. Go ahead. Go ahead, Chris. Medical care services. Yeah. Yeah, exactly.

This is telling us prices fell 1.5% of the last year. fell 0.24% of the last month. This is a measurement issue. We've talked about this on the podcast before. Yeah. This might be sending a little bit of a false signal. It's not a huge component of the overall CPI basket, but it's not represented. I do expect this to reverse, right?

This goes to health insurance, the way the Bureau of Labor Statistics, the keeper of the data, measures the prices for health insurance. Bernard, do you want to, I always botched the explanation, but do you want to take a crack at it? You know, how the BLS measures this or or or or not? So it was the they're looking at when the BLS tries to measure health insurance, they're looking at the retained earnings of health insurance. So during the worst of the pandemic, everyone was foregoing routine visits to the,

to the doctor. They weren't having, you know, life threatening or they, they weren't having necessary surgeries. So insurers weren't paying a lot of premium, so the retain earnings really shot up. And I think in the year before, the health insurance CPI was really adding significantly to the overall CPI. But then this went in reverse this year as people were going back to the doctors. You know, after the pandemic, everyone was going back for regular appointments, routines, you know, surgical procedures. and then that retained, those retained earnings of health insurers was crimped or was, you know, was

compressed. And then that has led to consistent, you know, these are very sticky prices. They only really change. They're updated by the BLS like once a year. And this is not, this isn't going to be updated until probably later this year around September, October. I think October. So they've been consistently, health insurance prices have been consistently falling by about three to four percent, uh, month over month, uh, over the past 10 months or so. Uh, but that's going to come to an end. Um, and, uh, once that does, that's also one source, one method, methodological quirk that's been weighing on the CPI that's going to go away. Yeah. So I think it's, you see all these negative month to month, uh, numbers for the price of health insurance medical care services,

but that's going to become a positive, I think it's in the month of October. And now instead of being a drag on inflation, it'll be adding to inflation. Exactly. And it's more of a deal in the consumer expenditure deflator, the PCE, which is obviously important because that's what the Fed core CPC is what the Fed looks at. And this plays a much more, the weights are much higher, and I won't go into the reasons why, but much higher in the PCE than in the CPI. So this will be, you know, a bit of a of a, of a, of a, of a, of a, of a, of a, of a, uh, of a, uh, of a, uh,

in terms of getting inflation in back in. Okay. Let me ask you this. The, uh, as I mentioned, as I said earlier, let me ask you this. Um, is there any component commodity good service that may surprise us in terms of helping us out here and getting inflation back in, Bernard? Yeah. I, I think what, one surprise, uh, this month, and it probably will continue, and it was one that I just, that I mentioned earlier on, was the CPI for food away from home, so restaurant prices, because that had been rising pretty strongly. And I really think that this was tied to just strong wage growth, especially in the food services industry. And this was an industry that really was suffering from a lot, from high

turnover, from a lot of job openings. But we're seeing wage growth in that sector really moderate significantly, and I think that's starting to finally, you know, relieve a lot of that upward pressure that was on this particular category of the CPI. And just generally, that just, it just highlights the importance of wage growth for, especially for services, because, you know, empirically, you do see a strong relationship between wage growth, between excess labor demand and the labor market, and a lot of these core services excluding shelter components of the CPI and also the PC deflator. So if we do get more moderation, more slowdown in the labor market, I think some of these categories of prices will start to moderate. And I think that should help us get back down closer to the Fed's 2% target.

Got it. Marissa, any components that would help out here? Yeah, I actually just in our, my labor research piece this month, I wrote about the different components of wages across industries and the industry that's had the biggest decrease in wage growth over the past year is leisure hospitality, which is where much of that inflation has come from, right, in the service sector. So wages peaked in the first half of last year at almost 9% year over year and they're down to about 5.5% now, which is, is still elevated relative to where it was prior to the pandemic, but you're talking about,

you know, almost a 50% decline in the wage growth rate. So that should eventually work its way, right, through wages and then the prices consumers pay for food. And that is perhaps what we're starting to see a little bit of now. Got it. Hey, Chris, are you there? Yep. Any positives you want to call it? I know that's not in your nature, but I'm just, oh, gosh. Wow, that hurts. I'll throw out a shelter, right? The rent should continue to moderate here, but they're still pretty high on a month-a-month basis, even near to year.

But, you know, the private market indicators for new leases suggest decline, so that should bleed in, but it's not going to be immediate, right? It's going to continue to be a fairly lengthy process for the CPI to pick up these changes. But, yeah, should continue to help get us down to the Fed's target. Okay, so our baseline forecast, which assumes the Fed is done raising rates, the funds rates

at the terminal rate, and no recession, soft economy, some small increase in unemployment over the next year, but no recession, has inflation, consumer price inflation, top line is now a little over three, the core is a little under five, that by this time next year, they'll both be at the Fed's target at 2.5%. Bernard, what do you think? I agree with that. Assuming our, because I think our shelter for, yeah. Go ahead.

Sorry. Because right now, you know, over this period of time, you're going to get significant housing disinflation. And rents account for about, if we're just looking at core CPI, that accounts for about, you know, over 40% of the core CPI. Right. And right now that's rents are tracking at about 7.8%. year over year. Our forecast is for that to fall to 6% and then to fall below, you know,

3% by the end of next year. And I think that's doable. I think that's, you know, that's to be expected given the weakness that we're seeing in leases for new tenants thus far. So that's really going to pack a big punch when it comes to, you know, just allowing for the, for the CPI to disinflate closer to the Fed's target over this period of time. So you're on board with the baseline? Yes, yes. Okay. Risa? I am. Energy prices, you know, if they remain elevated and they keep going higher, that could mess us up a little bit. Yeah. Barring that. Barring that, yeah.

Yeah. Chris? Well, in the absence of a recession, I think it actually might take a bit longer, right, right for the reasons we described. So I think maybe a quarter or two to really get down to the Fed's target. So you're saying the end of next year. That's end of the next year. Unless we have recession or greater weakness, right? Then certainly that would speed things up. Right.

Okay. All right. Well, of course, I'm on board with the baseline. I'm all in on the baseline. It's my baseline. Yeah, I think. I hope so. I think we're on track.

You know, I do think this so-called last mile will be a little difficult. It's going to be two steps forward, one step back. But I do think by this time next year we should be back. close to that 2.5% target on CPI. Okay, let's play the game, the statistics game. That is, we each put forward a number. The rest of the group tries to figure that out with the questions and clues, deductive reasoning. The best statistic is one that's not so easy.

We don't get it right away. One that's not so hard, we never get it. And if it's timely an apropos to the topic at hand, which is inflation, all the better. Okay, Marissa, you're up. This is tradition. always begin with you. So what's your statistic? My statistic is 77.4. Seventy-7.4. Is it related to the inflation data? No. Is it, no? Is it, is it a statistic that came out recently? Yes. Is it the University of Michigan survey? It is. Okay. What component is 77.4? I think the overall is 71.4.

Although Marissa is prone to getting negatives and positives wrong. Could she be possibly gotten the 77 versus the 71 wrong? I am not prone, Mark. No, you're not. I guess. What, okay, guys, what in the present situation? It is. It's the present conditions.

Present conditions. Present conditions from the University of Michigan Consumer Sentiment survey. This was the August reading on present conditions. which maybe isn't that interesting in and of itself, but I picked it because this has risen for three months straight now. We're on a very downward trajectory, right? It's still very low compared to where it was prior to the pandemic. But in the past two months, for the first time,

the present conditions index has risen above the low point that it reached right when the pandemic started. So when the pandemic started in March of 2020, this plummeted. And starting in 2022, this University of Michigan survey has just been completely in the dumps lower than it was in the bowels of the pandemic. Right. So now for the first time, it's above that pandemic low, which I guess is good. I mean, it's a low bar, but, you know, it's still well below where it's. was prior to the pandemic. You know what I noticed in that report was the inflation one year ahead inflation expectations. I was considering making that my statistic. Yeah, that would have been a good one. 3.3%, which is not too far where I think you'd want it to be for consistent with the Fed target. Because if you look historically in a time when inflation is right where they want it, it's about 3%. So we're within spitting distance of, you know, that, that, that, that, that, that kind of

expectations number that would be consistent with the Fed target. That was good. That was very good. Okay, Bernard, you're up. So my statistic is 91.9. 91.9. That sounds like an index. Small business. Oh, it's NFIB. Exactly. Yep. Yeah. Mercer, I beat you to it. We'll have to replay the tape. Oh, come on. Come on. It's a replay, replay.

That is the overall index, right? Yeah, so I didn't want to go into some of the details there, but I didn't want to give some of the detailed statistics underneath. But one thing that is interesting about this index is it really speaks to the so-called vibes session. Everyone thinks we're in a recession, but they're not acting at all as if that's, you know, if that's really the case. And there's about 10 components to the NFIB index, and about five of the, half of them are what you can call hard data. So these are asking small businesses, what are their plans for employment, for capital expenditures, for inventories, there's also, you know, asking about their current job openings and earnings. And if you look, if you just like recreate a hard

data NFIB index, that's pretty, it's in positive territory. It's, you know, it's, it's, it's, it's consistent with an economy and expansion. But then if you take the other components that make up the NFIB index, which are more about expectations, these are more soft data, and you just compile them together, it's about as low as it's ever been in, you know, going back to the mid-80s, even lower than the, you know, than the great financial crisis. So, you know, the main streets, you know, businesses on Main Street, you know, they're very pessimistic when they look at the outlook. But when you ask them, what are they doing, are they planning to raise employment? Are they planning to make capital expenditures? If it was now a good time to expand or, you know, how many job

openings do you have? It's still pretty solid. All of this looks good. And this is important because they account for a significant share of employment, you know, of, you know, private employment. And I think that's why everyone was looking at a lot of these negative sentiment. But when you actually looked at the action, and people were looking at this, these negative vibes coming out of consumer, and businesses and saying, you know, we're, you know, we're headed for a recession. But when you actually looked at their actions, it told a much different story. And I think that's why we've, we've been holding it together strongly. Yeah, I just, it's so interesting, you know, this dichotomy between the hard data and the

soft data. You can see that in all these surveys, the ISM survey. That's the purchasing manager surveys. And even in our survey, we conduct, you know, we have a survey we do every week of businesses and you can kind of feel it there. the kind of the broad atmospheric questions that are very, very negative. The specific questions about jobs or investment, they're fine. You know, no problem. So it's just, I find it so fascinating. And maybe we should do a podcast on that, you know, maybe get a behavioral psychologist or something.

What the heck is going on? I mean, I've got theories, but I just, it's just, I find that so interesting. That's the case. That was going. Okay, Chris, you're up. All right. My number is 2.1. 2.1, and is it an inflation statistic? It is not. Ooh. Oh. If you don't get this, Mark, I'm going to be very...

It's a house price. Is it a house price index, Chris? No, no, it's not. Is it a delinquency rate? Nope. It is actually an indicator that you cover, Mark. Oh, I know. small, is it our business survey?

It is, it is. Ah, okay. Yeah, okay. Survey of business confidence. You just mentioned it. I just mentioned it. Yeah, yeah, you want to explain? Maybe you should explain.

You cover it. It's the diffusion index. Yeah, I've been covering it since 2003, by the way. That's when we first started that survey. Yeah, this is folks that are clients on the, they don't have to be clients. So you can participate in the survey. It's a weekly survey. We have nine questions.

And, you know, I mentioned there's some atmospheric questions around how do you feel about, you know, current business conditions broadly? How do you feel about the future six months from now? And then specific questions about hiring and investment, inventories, office space, finance, availability, financing, those kinds of things. Then we create a overall index. the percent of positive response is less negative, that diffusion index that Chris just mentioned. And it's slightly on the positive side, which is, you know, it's consistent with an economy that's kind of sort of treading water, you know, not in recession, but, you know, certainly growing below its potential.

And, you know, it kind of feels sort of like where the economy's been. But again, it feels like it's been, it's being weighed down a little bit by the, the, the, the atmospherics, the kind of the soft data, so to speak. But that's a survey that, you know, we've been doing for 20 years. And I encourage people to look at it, participate. You know, that would be, it's always important to have high level participation. So we'd welcome that. And you can do that off our Economic View website, the EV website.

Did I get that right, Chris? Did anything I miss? You did. You did. No, you got it. It's free. All right. I nailed that one, baby.

Yeah. It's free of participating and you'll get some, you'll get some, a report on it every week that you do. So there's a little give to get if a, you're interested in, yeah, and participating. Right, right. And I do find it very valuable,

particularly interestingly enough, the percent of respondents to the question about present conditions, you know, how do you feel about your business and how it's doing right now broadly, the percent that respond positively. That's like the, in my mind, the most useful in terms of gauging where you are in the business cycle. And we're right kind of on the edge of no recession, recession, you know, economy that's just kind of skirting its way through. And it's global as well.

So you might fund us some value. That was good one. Thanks for calling that out, Chris. All right, I got, I think I got a pretty good one. 2.5%. This might be a little hard. Inflation related. Oh, that's less, what is it?

Less energy, food and shelter. Oh, my gosh. You're a God. That is great, Chris. I was afraid no one was going to get it. I thought, you nailed it. Perfect. Because I saw that number, 2.5.

I said, this matches perfectly with Mark's narratives. He's going to, he's going to, that's out of it. You're, well, okay. Come on now. Listen. year over year through the month of July, CPI core, so mean exclude food and energy, it take out the shelter component. It's 2.5%, which is the target, the Fed's target.

And the only thing, reason we're not at target, if you buy into that measure, is the cost of housing, the growth in the cost of housing services. And as we've been discussing, we all know that that that. That's going to slow quite dramatically here. In fact, we forecast lots of stuff, some of which we're very confident in some, not so much. This we were pretty about as confident as you can get in forecasting anything because it's tied to rents with a long lag.

Those market rents are flat to down. And then we know that's going to translate into slower growth in the growth in the cost of housing services over the course of the next year. Thus my baseline forecast, a year from now, you know, growth of cost housing services. is going to be normalized. It's going to be around 2.5%. And the overall index, the core index, is going to be a 2.5%. We're going to be a target.

Right? I mean, isn't that compelling? That's a compelling argument. What about those medical services you just talked about? Yeah, but all those other things, you got cross currents. You got medical services inflation going up. You got electricity cost inflation going down. You got new vehicle prices maybe going up briefly for UAW.

got used vehicle prices going down. All those other things, you know, things obviously can happen between now and then, but, you know, barring something really going off the rails, all those other things feel like they're awash, you know, some ad, some subtract the net of all that is, you know, no big impact. No, that's not, I mean, I looked at that and I go, oh my gosh, I couldn't believe it. I couldn't believe it. Very consistent. Marissa, what do you think? You can be convinced? It is. It is. It's compelling. I, I, I, I, I, I, I, I, I, I wonder about shelter costs. Does the OER component of shelter tend to lag rent? Okay. OER. Okay, OER. Owners equivalent rent. So it's the implicit rent that a homeowner would get for their home, were they to rent it essentially? So it's an implied calculation.

And I just wonder if you really need actual rent rent to moderate before. before that sort of works its way into the OER component? I think the answer is yes. I mean, the market rents are a basis for them constructing the owner's equivalent rent. So it's a complicated, like everything in the C, like every data statistic, I guess, a very complicated, you know, process from going from rents to measure prices. but yeah, that's effectively what they do.

Bernard, right? Yeah, they generally, yeah, and you generally see tenants, rent and owners equivalent rent. They move the same. They move the same. Yeah. They try to get rents for homes that would be more consistent with homes that people own, you know, so they try to line that up to make that work better.

But they still ultimately goes to rents. Yeah. Yeah. Yeah. Because OER is the bigger component of shelter. Yeah, by far, by far. Yeah, because two-thirds of people own their own homes, one-third, you know, right. Here's the other interesting thing that, you know, if you think about it for a second,

you go, oh, and it's important, you know, for people who own their own home, right, two-thirds of the population, they either own the home outright, I think half of people own their own outright, and half of people have a, a long 30 year, 15 year fixed rate mortgage. Very few people have mortgages that adjust with market interest rates. So their cost of housing, you know, the actual cash they're shelling out to pay for their housing is not changing. It's not changing at all, right? The cash outlay is not changing, but their cost of living is increasing as measured by the OER. So the actual economic a consequence for their finances is much less serious than, you know, if I have to actually shell

out more for food or for apparel or for gasoline, I'm actually, I'm selling out more cash. In this case, you're not, right? Isn't that interesting? I mean, I go, duh. It just sort of dawned on me, you know. Chris, right? Am I missing something? Well, that's right.

I guess it would apply for, well, to some extent, for cars, too, right? Yeah, that's true. That's true, too. Yeah, true too. Yeah, you're not, as you say, the CPI has a lot of complexity in it. Yeah. I think we summarize it and we use a lot of shorthand, but there's a lot of detail here, both how it's measured and how to interpret it. Right. Well, that was a great conversation about the inflation statistics. I think we covered a lot of grounds. I think we, at this point, better move on this is going to be a very long podcast because we have a great guest, and let me welcome Sebnam into the conversation.

Sebemnum, good to see you. How are you? Good to see you, Mark. How are you? I am very well, thank you. And, you know, we met a couple, three months ago at the New York Fed. That was a lot of fun. Yes, definitely.

We're both on the, I guess it's called the Board of Economic Advisors or just? Yes, yeah, exactly. Economic Advisory Board, yeah. Right. And this is a board of a board. of advisor set up. I guess we meet a couple times a year, maybe more than that. Yeah, yes. It was, I think, four times before COVID, during COVID, it went down to two times through Zoom. Yeah. So we are still in that phase, I believe. Right. And we talked about,

it was a couple of three months ago, so top of mind at that point was the banking crisis. And I want to come back to that. But before we kind of dive into the subject matter, maybe you can give us a little bit of your background. I'd love to know a little bit more about your success and how you, I should say you're now a professor of economics and finance at the University of Maryland, and I'd like to know a little bit more about your background and how you got there. Sure. I actually, you know, I'm originally from Turkey. I went to college in Turkey, Middle East Technical University, and then I came to United States in 1995 to do my PhD. I did a PhD in economics at Brown University in Providence.

And after that, you know, so that was, you know, 2000. So I got my PhD 2000. So last 23 years, I have been busy doing economic research, you know, trying to get tenure and all that. And at the same time, visit policy institutions. So my work is in what we call macroeconomics broadly, but it is international finance and international macroeconomics. And it's very policy relevant applied to policy.

So I work on things like transmission of US monetary policy to other countries, inflation, capital flows, globalization, you know, those type of issues. I started at the University of Houston, actually. At that point, we moved there in 2000 with my husband. And then, you know, I have my kids there. I have two sons. Now they are 21 years old and 16 years old. They are there now.

Yeah, really old. I'm remembering those days when they were little. So then I was at the University of Eastern for 10 years. After that, I had like stint at Harvard Kennedy School. I was at European Central Bank, right around the entire big crisis of 2007, 2008. I remember actually being at the European Central Bank and the chair then, Trichet, was saying, oh, this is just a little thing in the United States.

It's not going to come here. It's just a little... I remember that. And I'm like, that just not possible, given the extent of global financial linkages because, you know, that is my area of expertise. Anyway, so kind of we did a lot of work on that. Was he raising, as I recall, like,

right in the teeth of the financial crisis, they raised rates, as I recall, right? No, exactly. It was just like, every one of the moments. Everybody was like running around like headless chicken, right? Nobody knew what they're supposed to do. He was saying things like, oh, you know, Ben Ben, Anki and I, we were talking every day. But that was actually the key moment for my research in a sense that I saw how important and relevant my research for policies. We wrote the first piece that shows the exposure of European banks to Greek debt. And this data, is now very well known, BIS, Bank of International Settlement State,

that was sitting there at the European Central Bank, nobody was using it. Nobody even knew it was there. I mean, like, you would think, okay, if you're integrating several countries, you want to know the exposure of your banks to other countries debt, right? That's the first thing you would want to know about.

Anyway, so this came out in Journal of Finance, which is the top journal in finance. So we published there. Then, of course, it became very fashionable. I mean, this is 2008, 2009. After that, I came back. I was in Turkey also visiting a couple of universities there,

Coach University, Brooklyn University. Then I came to University of Maryland. I have been in University of Maryland last 11 years since 2012. And, you know, it has been great. I, you know, had a lot of time because I was at University of Maryland spent at IMF, World Bank, Federal Reserve. I visited all these institutions, long periods of time, which helped me a lot to understand the linkages

between academic research and policy application, how important it is to bring the state-of-the-art knowledge from academia to policy folks, right? Call it IMN, call it Federal Reserve. And, you know, this is where I am right now. So I wrote a paper for the Jackson Hall Conference in 2019 on the spillovers of US monetary policy that became a big head. So, and then, you know, now, you know, I'm here doing my research. Enjoying. I am actually we are now going to move again next year, 2024. I am going back to my alma matter. I'm going to be a professor at Brown University starting September 24. Yeah. Congratulations. Well, good. Thanks again for joining us. I know that you've done a lot of work

with regard to the recent banking crisis back in March. In fact, that gave a presentation at the New York Fed, with President Williams was there and the rest of the Fed staff. And here we are three or four months after that crisis. And, you know, it strikes me that the impact, the fallout, has been rather modest, you know, in the grand scheme of things. I mean, if you look at, yes, the banks have tightened up under underwriting standards. If you look at the senior loan officer survey at the Fed conducts a recorder that shows a further tightening and underwriting. underwriting. But in terms of its impact on actual lending activity, you can go look at the Federal Reserve's H-8 release, which shows the assets that the banks have and kind of gives you a pretty

good sense of their lending. You know, there's been some weakening in commercial industrial lending, CNI lending, but in terms of commercial real estate lending, multifamily lending, construction land development lending, it doesn't, you know, looks slowed, but, you know, hasn't really fallen off to a significant degree. And also deposits, you know, after an initial decline back in March, they appear to stabilize both for large banks and smaller banks. So I guess the question to you is, am I characterizing this right? Are you coming around to the same conclusion? And what do you think is going on here? Yeah. No, you're exact right. And if you remember that presentation at New York Fed, Mark, one of the things I was saying, at that point,

we don't know if this is going to really turn out to be a huge-scale banking crisis, like the 2008 version. But my expectation at that point was it wasn't going to be. So basically, I predicted the situation. And that expectation and prediction is based on the fact that I look at granular data. I mean, this is what my research has been. I look at these linkages between the real sector and the financial sector, but not just, say, you know, the entire corporate sector and the banks or the commercial real estate and that and that. It's literally at a granular level.

So go and ask question, you know, where does Mark and Shabnan borrow from? So, you know, what is in Mark's portfolio, Shabnash portfolio, or Goldman Sachs portfolio, or, you know, Apple's or Amazon. I hope you don't know my portfolio. Hopefully you don't know my portfolio. I'm just saying, yeah. The point is you have to be at a very granular level. The problem is why people don't panic and, you know, said, okay, this is going to be big, big.

I mean, the economy is going to solve. I don't know. Because everybody talked about this started in regional banks, in the small banks. But it can, that can, you know, that can be two things that can go very bad. One, it's just a compagion, right? Everybody's going to panic. and, you know, now this is going to show up in Bank of Americas of the world, J.P. Morgan's of the world, number one.

Number two, these guys are the regional small banks and small firms borrow from small banks. And then this means once those firms go under, there's going to be a huge impact on employment because small firms are the bread and butter of the economy. Okay. I explained in that presentation, first of all, this is not correct, right? This is this, I don't know why, but it is just very deeply ingrained thing in people's minds because people only look at like apples and Amazon's off the world, like listed firms in Compuistad firms and then, you know, so these kind of large guys,

so and then jump from that conclusion that, oh, small guys must be borrowing from small back. This is not true. U.S. economy is super heterogeneous and unless you look at literally like every single small firm, every single small and big agent Mark Chapman versus Apple, Amazon or like this 100 employee firms versus 3,000 employee firms, You wouldn't know who is borrowing from who and who is exposed to what, right? Same goes for the banks, right? We understand these small regional banks like SVBs of the world did take interest rate risk, right? They didn't do their diligence, which we can link back to the regulatory failures.

But the bottom of the fact is there are other banks in the economy, large banks like Bank of America, they are subject to regulation. They didn't take that much of this risk. And small firms do borrow from those banks. So in fact, the results I showed in that meeting is from our work, not rely on H8 data. You said, like, at the beginning, people were looking at this H8, some commercial loans. These are all, like, kind of these. Just to stop you for a second.

So the H.A. is the data that the Federal Reserve puts together on bank balances, their assets and liabilities, and they release this every week. So it's an aggregation across. It's an aggregation. And not every bank is in it. That's another thing. The big advantage is going to be that is something like that most high frequency, B2 quarter, so people just go and rush to age eight or data sets like that because to find out the information quickly. But the big disadvantage is not everybody in it.

You know, so it doesn't cover every single bank and it's not going to tell you anything in terms of which firm, which company boroughs from which bank. That is the data called Y-14, which is also federal reserves regulatory data, we work with that data. This data has been started collecting after the Fed started collecting this data after 2008 crisis exactly because of the purpose of we want to understand where the risk in the economy and how like these isolated risks like the subprime of 2008 can be systemic risk, right? Can become like economy wide. So we work with that data and that data, I mean, is going to cover a large,

set of almost universe of the firms in the United States, a represented data set. So you would know the guys with like, you know, less than 500 employees, what we call SMEs. And at the same time, you still will know the guys like Apple and Amazon. And you have a more complete picture who borrows from who. And when you look at that data set, going back to my presentation at the New York Fed, we see that small guys borrow from big banks. So which brings me to the point that as long as these regional stress, you know,

banking stress like SVBs don't, you know, jump to the big banks. As long as the big banks' balance ships are safe, we are not going to have a crisis because small guys are still borrowing from the big banks. And small guys are very strong demand. Remember, this is the other point I made. Unfortunately, in this literature, in this topic, we think a lot from the supply side, supply of credit side. So, oh, if banks are in trouble, they are doomed, right?

This kind of was the case in 2008. but of course all banks were under trouble then, right? All banks, not just like SBB and First Republic and all that. We have to understand there is a boom side to this picture. There is a side when we are not in a financial crisis, when not all banks are in trouble, the boom, meaning the demand matters a lot, the customer demand, the credit demand, and that's the situation we're in. This is the situation Fed is trying to slow down now over 15 months.

Still, not there. We have a strong economy. demand is strong. I mean, if the customer demand is strong, that firm is going to go and demand credit. And if a, you know, safe bank, like Bank of America wants to give that credit, then you don't have any problem. So this type of attorney is very important to understand one. Okay. So what you're saying, just to summarize, is the fallout from the crisis has been modest. And one of the key reasons for that is that small businesses have been able to get credit because if you if you're you know if you can take a closer look at the data at a granular level

as you as you said you'll see that small businesses are also borrowing from the big guys the jp morgans the b of a's the wells fargos and continue to have access to credit and that has allowed them to continue to operate and allow the economy move forward that that's kind of the message that you're exactly exactly got it but let me ask you this so one concern is is that, of course, the Federal Reserve had to respond. Fed, the FDIC Treasury responded, guaranteed the deposits of whether folks are insured or uninsured, you know, in SVB and the other tribal banking institutions. The other thing that the Fed did was establish a funding facility to allow banks to borrow

against their security holdings and they could value the securities. that par, not at their lower value given the higher interest rates. And that program is still in place. And it's, you know, if you look every week, you can see that data as well from the Fed every week, the so-called H4, that continues to increase slowly but surely over time. So it feels like the system is still under a fair amount of stress. And one concern is that the, given the Federal Reserve's very aggressive of rate hikes and the inversion of the yield curve, that banks are under a lot of pressure because their net interest margin, their difference between their funding costs and their loan lending rates is under pressure. Now, they've been able to manage that, particularly the big

guys, as you point out, they've been able to manage that, you know, up to this point in time, net interest margins have held up pretty well. But as time goes on here, it gets increasingly more difficult for banks to do that. You know, they hedge, they match, but that gets very cost. very difficult to do. So their net interest margins come in increasing pressure. So if the Fed has to keep its foot on the brakes for an extended period, the yield curve remains inverted for an extended period, the worry is that the banking system, which is still under a lot of stress, the bank term funding program continues to be used at a very high rate, something's going to break in the system. What do you think? Is that a concern overdone or is that a reasonable concern?

No, no, it is definitely a reasonable concern. You're exactly right. But at this point, as you said, Fed has just underwritten the entire bank existing, right? I mean, that's those policies dead. And yes, we can look at, you know, who is using those who is withdrawing from that and all that. But that's the guarantee. Now, of course, that was an emergency panic moment, you know, underwriting. We shouldn't be doing these things like that.

Now, of course, I mean, this is why if you were, you know, following the entire, you know, media coverage of this, emerging market banks were laughing their head off, right? Because it's the emerging market banking 101. Nobody would do this. I mean, you wouldn't have an emerging market bank. As you remember, Brazilians were saying this, that would take this risk, right? I mean, you are in a tightening cycle. Every emerging market bank would know what would they do in a tightening cycle and a losing cycle.

So clearly, you know, this didn't happen in the United States. You're saying that this is banking 101, meaning no one would have gotten caught with this interest rate mismatch problem. Exactly. But it's called interest rate risk, you wouldn't because you would and burn. Of course, they learn it the hard way. I mean, all these countries went through banking crisis because of the similar situation, especially in those countries because inflation is more volatile.

You go to this easing and tightening cycles of monetary policy more frequent, right? So they learned the hard way, but also regulation came. I mean, after banking crisis, after banking crisis, if you look at the emerging markets right now, all the banks are regulated. All. It is not like the United States where you have these, you know, 50 guys, the big guys are regulated, which is how we get the data, the Y-14 data. And the rest is not. And, of course, in the United States, we have a huge number of banks, right? We are talking about, I mean, 3,000, 4,000, whatever.

I mean, we came down from 15,000. So I guess, you know, so that's over the last 30 years. But still, it's a huge number of banks. There are a lot of small banks. and they are not regulated. The way out of this problem is every bank should be regulated. I mean, I say this all the time. There are other people inside the Fed and outside sharing this view.

This is what we learn through the bread and better, bread and butter of banking crisis in the emerging market world. You regulate everyone. I mean, the minute you have these type of, okay, I'm going to regulate large guys because large guys are the systemically important guys. I will let the small guys be because they are small and regulation is costly for them. These things are going down. They're regulated.

You're saying they have the same regulation, the same capital standards, same liquidity requirements. You can think about that. You can fine tune that. You can fine tune and like, you know, think the regulation in a countercyclical way in terms of, you know, proportion to their size. But basically, you should have, you know, they should have been prevented from taking this type of interest rate risk on their balance sheet during a tightening cycle. That is probably regulated, but you're saying they weren't regulated significantly enough.

They didn't. Yeah. Okay. So the Silicon Valley Bank shouldn't have been able to do what they did. Exactly. Because the interest rate risk exercise, if you look at the other guys, the big guys, part of the CCRA, that's the stress testing exercise and the big banks part of that. And I say regulated.

Yeah, I'm using regular. So I'm abusing terminology. Sorry about that. But when I say regulation, I'm talking about the regulation that the large guys, large banks, Bank of Americas of the world are subject to the part of that regulation is this interest rate risk, right? These exercises wrong for them, right? That's why they have a very diversified balance sheet.

They don't have this type of, like, you know, low returning asset, completely filling up their asset side of their balance sheet, right? Because they are subject to these types of this type of testing. stress testing exercise and interest rate risk is part of that during a tightening monetary pole cycle. Now, this wasn't done for the small guys because small guys, they weren't part of that. So this is what I'm saying. When I say regulated, you know, everybody should be regulated for all sorts of risks, basically. And this is a hutch a plain one in the risk, right? I mean, interest rate risk during a tightening cycle. This is why I'm saying is emerging market banking

one-on-one. Yeah. So, okay, so you're saying the reason why SVB signature and other smaller institutions gotten into trouble here is because they were not well-regulated. They don't have a diversified portfolio. Their balance sheet is completely, their asset side is completely filled up with these low return, you know, that U.S. treasuries and stuff. So, I mean, you know, you have to diversify. You have to have a diversified portfolio on the asset side. And then the liability side, they also have a problem with the liability side, right? They have the same type of depositors. These are, this is the tech guys, right?

This is why they became in a, they, they, they caught up in this thing. They, all their depositors are same group. They text at each other. Let's get out of this bank. And then their assets cannot, you know, meet that type of all depositors going at the same time because it's not a diversified portfolio on the asset side. Just to push back a little bit, some would argue, and I'm sympathetic to the argument, that it isn't about regulation so much as it's about the implementation of that regulation.

Supervision, yeah. Yeah, no. Supervision. Let me clarify. In fact, one of my very early Bloomberg in terms on this topic, I did say exactly when this question was asked, is it regulation or supervision? I said, I might be abusing the word regulation. But the supervision, it is a failure of supervision, but I think supervision comes with regulation, right?

I mean, if the regulation tells you, okay, you know, you have to be supervised if you were taking interest rate risk or not. And it's kind of very, you know, that and forth. And supervision will come together with that. And, okay, so, you know, I'm supervising you. I look and then you have so much interest rate risk on the balance. So changes. But, I mean, you see, they go together. It is a failure of supervision.

I fully agree. But if the supervisor had no way of enforcing it, I mean, this is a story, right? I mean, we did actually heard that Federal Zero San Francisco did tell them this is not good. So they were warned, right? First Republic, definitely, that there was a warning sign, but they didn't do anything about it. So that's the thing. These things go together. It is a failure of supervision.

But if a supervisor telling you, look, I don't like this, this is dangerous. Then if the bank is saying, fine, I'm not going to do anything about that. Then, then, you know, what about how are we going to get out of that situation? So that has a sort of enforcement mechanism. Just looking so going forward. So the system is the financial, banking system, financial system is still under significant pressure. I mean, the Fed has put flat on the brakes, curves inverted, and other aspects of the operating environment that banks, you know, are dealing with are more difficult. credit qualities eroding, delinquencies defaults are rising.

Loan growth, it's still positive, but it's definitely slowing. The tightening and underwriting is slowing loan growth. We've got higher regulatory costs. The Fed and other regulators came forward with new capital standards and liquidity requirements, and that's going to be more costly. Supervisory costs are up. So you kind of add all that up and says, okay, the bank's, they're under a lot of pressure here.

And it feels like something, you know, as long as the longer this goes on, the more likely something's going to break somewhere. Is that a risk? I mean, are you, how worried are you about that? Or am I just overstating things here? No, no, there is, but I don't think it is, it is right to think that it is going to come from the bank side. I mean, banks are under pressure, banks are on the bank side.

I don't think that's going to be from that. side because banks, I mean, let's face it, after 2008, a lot of regulation rolled out. Banks now are in much better shape than they were in 2006 and 2007. So I don't think, again, unless like a huge shock happens like that, like, you know, what happened then, everybody is back, everybody exposed to the same toxic assets, right? Unless we find out something like that going on, it is not going to come from the banking side just because Federal Reserve of tightening mantra post. Remember, this whole notion of Federal Reserve in a tightening cycle, so banks are going to break. I don't think this is correct. Yes, there are going to be some

banks breaking. They already broke, right? But that's because of their own mistakes. So the system as a whole, like if we again compare to 2008 is, I think, safe. I think the danger is going to come from the real side, the real economy. And that is going to depend on, you know, which loans they gave out the banks to who. I mean, if during this zero lower bound super low interest rate era started in 2008-9, if they really gave out bad loans to bad customers, yes, then, okay, obviously at some point the real economy is going to slow down and those guys are going to start defaulting on those. And if the bank, again, on the, you know, asset side, similar to this, you know, the low-yielding treasury story, if they literally focus on those type of customers,

firms and households, right? I mean, then, then, yes, then we are going to have a problem at our own. But I don't think that was the case. Yes, banks did give out some, you know, probably shaky loans during this cheap credit era, but I don't think it was that concentrated that everything is going to blow up at the same time. I think what is going on right now, And this is the question of soft lending, right? If Fed can engineer this soft lending immaculately till the end, right, till we'll come down to 2%. Sure, we are going to see some sort of defaults there and there, pockets of it. But as long as the entire SMEs, which, by the way, 99% of all the firms in the United States,

and they account for 70% of employment in the United States, if that entire group, you know, go under, If that doesn't happen, then we don't have a problem. We are going to see things, but we are not going to have, like, a huge crisis and recession, right? But that's a thing, right? And that comes back to soft lending. If the soft lending fails and if somehow going now from 3.5 to 2 is going to involve very, very quick slowing down of the economy, so demand is kind of like crushing, then we are going to have a problem now, right? Of course.

And that's what we are all, you know, hoping won't happen. and Fed so far has been successful in that, but of course it's yet to be seen still. We are not fully there yet. Just FYI to the listener, SME is small, mid-sized enterprise. So effectively small business. It's kind of the acronym, mostly I think European, maybe global, but most people, Chris, do people here in the U.S. say SME?

I don't know. No, this is true. Yes. People say small businesses, but globally, That's what you mean. But this is very important. I really want the listeners on this. These guys always thought, oh, this is just a mom and pop shop, the pizza store on the corner, the dry cleaning.

No, these are firms less than 500 employees. They are 99.9% of the universe of the firms in the United States. Just to give you a idea, the average size in these firms are going to be something around like, you know, 50 employment average. The average size of the level. listed firm is like 4,000. So I mean, these firms are day and night. The problem is the big guys is like 0.1% of the economy. In terms of employment, which is the big deal, of course, the SMEs run the show.

I mean, remember the PPP program. When the PPP program launched Paycheck Protection Program during COVID, the entire thing is like that's for SMEs, right? To save firms under 500 employees, that was done to save the economy because these firms are the backbone of the economy in terms of growth, employment, and innovation. So we just, we just ignore these guys because we don't know much about them, because first of all, we don't know anything about their financing. They don't, you know, they only file returns to tax records. So there isn't any publicly available data we can look at it. But they are very important. And if they

go under in large numbers, yes, then of course we are going to have a recession in our hands. But as long as, you know, not all the banks are in trouble, some banks are in trouble, but not all of them. And as long as there's still semi-strong demand in the economy, the economy is not, you know, going to a recession with like flashing light, like high speed. These guys are not going to go under in bulk in my opinion. Okay. So what you're saying, because I want to make sure I got it right, is you don't think the, if something does the economy in, it's not going to be the banking system or the financial system. That's not where this is going to come from. Something else has got to happen.

What you're saying is, you know, the banking financial system could have a problem. Yeah, no doubt. But that's got to be because of something going on in the economy. And you're most focused on the small business or SME part of the economy. Yeah. All right. Yeah. I want to go on to talk about monetary policy because you kind of brought that up.

And I think we should explore that. But before I do, let me turn to Chris. And Chris, what do you think? You want to have any comments on the subnems, which he's been saying so far, any push back there? I guess I was struck by this idea of regulation, that we need more regulation across the system. And that may very well be the case. But then I think you're also making a philosophical statement in terms of the structure of the banking. Do we have too many banks, right?

Because if you increase the regulation on those lower, on those smaller banks, you're going to see even more consolidation. into a system that's more concentrated in these larger units. So if that's what we want, if that's what we think is optimal, that's fine. But I think I don't think we can have both. I don't think we can have much more regulation across the board and still maintain a very heterogeneous, diversified type of financial system. Yeah, no, I fully agree. This is again, this is something very fiercely debated in the literature,

in academia and in political circles, both. And I mean you can write down both models, right? You can write down a model where it is optimal exactly to consolidate, as you say. And you have, you know, fewer banks. So we have the consolidation, but they are fierce regulated. So we decrease the risk. Or you can also write down a model where it is optimal to have a heterogeneous diverse system with many, many, many, many small players that keeps up the competition alive in the system.

You can write down both models and you can have an optimal policy coming out of our model. This is why we have our jobs, right? I mean, this is what we do in academia. I mean, write down these things, like competing models and then go and test them in the data. I mean, this is exactly like data and granular data is super important. Microdata, bank level, household level, firm level data is super important to test these different models that will give you different optimal policies.

And my view is, I think, you know, we are, again, I mean, these risks, they kind of accumulate over time and if you have too many small banks and yes there is a competition advantage there is a heterogeneity diversity advantage but there is also a big disadvantage that you don't see them and then they can easily overnight turn into a big event and then it is going to be harder to clean up the mess and all that so you this a trade off you trade that risk with you consolidate you have a, you know, sharper, you know, bird eye, right, view because you are going to regulate all these guys. Yes, now you decrease the competition because you are, you might, you know, have a, you know, monopoly, monopoly banking sector problem in your hand, but you are, you're going

to have a better handle on the risks in the, in the system. So this is a trade-off, right? So, which, which one you do? So, I mean, and again, it's, it is not clear. The answer is not clear. I agree with you. I don't know if I've ever told you the story. But, you know, I started a company, an economic consulting firm. I sold to Moody's, you know, started with my brother and a good friend, and we sold it to Moody's about 15, 16 years ago. And we were a small company early on. We needed, we were expanding, growing quickly, need a loan.

So I go to a, I live in suburban Philly, so I go knock on the big regional bank. I won't tell you who it is. You'll figure it out. But I knocked on the door. If you can guess, hey, I need a loan. the big regional bank said no what do you you're out of your mind it's not going to happen and you know if I were in their shoes I'd probably say the same thing because you know I had no assets I had a home probably had 5% equity in it so fortunately though I was a coach of my daughter soccer team and on that

team was a young lady whose dad was the president of Malvern federal savings bank, three branches, Malvern, Pennsylvania. And he said, I'll give you a loan because he knew, he knew me, he knew me personally. And he knew I would die before I wouldn't pay him back. You know, it may take me 50 years to pay him back, but I would pay him back. I got the loan from Malvern Federal Saving Bank. So, you know, from that experience, and I, you know, obviously, we're all in on data, said, you know, I agree with you. But I like anecdotes as well. based on that anecdote, I go, you know, I kind of understand what, why we want a lot of small banking institutions, because they are really critical to those SMEs you were just talking about. Yeah.

No, not true. I mean, again, yes. I mean, so the very, so this is between the startup SME and an SME, right? I mean, that you can be still small, but you can be a business in 20, 30 years, then you will get your loan from the large guy, right? So, but yes, if you are a startup, that is true. It's for small businesses that are younger than five-year-olds. So there's a size issue and there's an age issue, right? So you guys are starting like your case, Mark, it is important.

You want that kind of neighborhood bank that either you have some sort of a personal connection or you can go and plea your case. And yes, these guys are important. I'm not saying have JPMorgan buy out the entire industry and we go down to one bank. I'm not saying that. But at the same time, I mean, it's 4,000 the optimal number. I mean, you know, so this is a thing. This is something we need to study.

I mean, maybe, maybe, yes, we don't go to 60, but maybe it's 200. I don't know. But we do need to protect some of that very American, you know, I'm going to go to my neighborhood bank. I will start up this business. We do need to keep that. I mean, that is very valuable. And yes, that is you need to America. I fully agree there.

But at the same time, we need to find a way of better regulate, better supervise, right? Maybe think about ways of not having regulation costly. So we keep these guys, these, you know, smaller banks, but make sure we supervise and we enforce that they don't take this type of risk. So we have to find a better way here. Yep, got it. Let's move forward to monetary policy and you brought in the Fed. here we are. The Fed has been raising rates now for about a year and a half. The funds rate target is 5 and a quarter to 5.5%. What do you think? Are we kind of at the end of the rate hiking cycle here? Are we at the terminal rate or is there more to go? Yeah, I think we are at the end. I mean, so my terminal rate expectation has been now for some time. I mean, I have been saying this now almost 10 months. We are going to end somewhere between 5.5, 6.6. Shish, I don't expect to go over sick, but six.

I like the ish part. Six can happen. This is in my range. So maybe we will stop at 5.5. Right now, we are 5.2, 5.5 range anyway. But we are at the end. I don't expect rate cuts, though. So here where I differ from the financial markets,

financial markets are pricing and interest rate cuts way earlier than myself and some other fellow economists. But yes, we are almost there at the terminal rate, although I expect they stay here for some time, in the absence of a very, very, you know, harsh and deep recession. Again, this is a soft lending debate, right? And are you, do you have a view on that? Do you have a view on soft landing versus recession?

Yeah. So I do think Fed is going to succeed in this. I think it's going to get a safe planning. Chris, do you hear that? Chris is the bear. I'm just, did you hear that, Chris? I am hopeful.

I hope that's the case. That's also. I'm also a very positive and hopeful person, but I have been saying this now for some time, not just because I want it to be like that and be positive and hopeful, But because of the research, we did these very early papers on COVID inflation, starting as early as January 2021, actually.

We were in the group that says there is going to be inflation. But we also said, you know, Larry Summers is right for the wrong reasons. In fact, if we were it exactly like that, that's us. I'm right with you on that one. Exactly. Yeah, yeah. You're saying it's the supply side, more supply side. So we said very early, and I had a presentation like literally, I mean, WHO presentation.

in January 2021, before everything else. There's going to be inflation, but it's going to start with the supply chain, right? So it's going to start with the supply chain with the product prices. I mean, now there's a new paper by Ben Ben Nankan and Olivia Blanchard. They also show all the same thing. It's not pages first. It's the prices first. That's complete links to the supply chain problem.

This is global, of course. This is not just United States. This is, you know, local supply chain and global supply chain going back to China. So we did the first paper on that. We did a second paper showing how when fiscal stimulus came, put that on. store rates, right? You start with the supply chain problem, inflation starts. Then, of course, you know, maybe you would have stayed at five, you went to nine, thanks to this huge fiscal stimulus, right? That's the demand size store. That's the second phase. And then, of course,

the final phase, the Russia and Ukraine obviously added to that more severely for Europe, of course. But now we document all these three phases of inflation, pandemic, are inflation, starting with the supply chain issue, fiscal stimulus, of course, you know, amplifies that. And and then you add the energy. So we are coming down. So in that sense, you know, we always told this can be a soft landing, right? Because the shock process is just very different. I mean, you know, people compare to 1970s, but I don't think that's that's right. Compare it. That's just a part of it. You have a supply shock and a demand shock happening at the different times. And there's a sector of dimension to this. And there's a global dimension to this. Right. It's not just energy

or it's not just, you know, manufacturing sector. It is like the services, the labor market. I mean, the labor market came to the picture because of, of course, the huge demand increase in the services sector, which combined with the recovery and opening up. So given all this research, I always told, you know, a credible tightening cycle clearly communicated, right,

which is what Fed was trying to do, which, by the way, we should all give it to the fact. Very hard to do because you get out of forward guidance and you go to a data-driven policy, a data-driven policy, is extremely difficult to financial markets because financial markets are forward-looking. They want to know the future.

They want to know the future. So that's how they were. And then you go and say, well, I'm going to look at the data and I'm going to look at six different indicators of the labor market and the energy and the, you know, so all this, it is very difficult to communicate. But basically, the research we have done says

such a different environment with several shocks happening different times in the economy and a clearly communicated and consistent tightening cycle can, you know, engineer a soft-magnet. So in that sense, we never, our research never hijacked by this, you know, Phillips curve story because, I mean, if you always think in terms of the Phillips curve and say there's just this slope and it was flat, now it is steep, this is limiting to us in our, So we work with these network models. You know, these are also a very complicated model, but basically you can connect every single sector to each other locally and globally.

So, you know, when basically you don't import steel from China, the effect of that in the steel sector and then the labor steel sector users and the wage group, we can quantitative trace this out. So in that sense, we really like our research, of course, but stand behind it that this is in our view. This is the best way to quantify what, you know, the drove inflation when in 2020, 2021, 2020. And then once you do that quantification, you can see that, you know, why Fed is going very careful and why they keep talking about these different sectors of Bitcoin, right?

Remember, they said like, okay, so there's the headline, the core. And, you know, then you peel that, the famous onion analogy of John Williams, New York Fed President. know, then there is the P.C., then there's the X-Shouter one, and there is the, you know, so all these, because of the nature of this shock. And Fed had been right in looking at this all along because the nature of the shock is you have different sectors being different times with different shots. And then you also add to that the global dimension of the problem, you know, it's a very, very complicated problem. And I, you know, not really. Not really.

Really, Martin. Come on. You get a pandemic. You get supply chain disruptions. it messes up the labor market. You get a Russian war in Ukraine and well, prices go skyward. You know, it's pretty straightforward, you know, in my view. The narrative is very straightforward.

That's, I feel like that. But to get a handle on that in terms of quantification with numbers, this is difficult. Why? Because because of the models, the, the, the, the, the fact works. You're saying disentangling the supply shocks from the demand shocks isn't. And also how long it takes. And also, you know, so recall the, I mean, the debate.

in the past 15 months has been about that. How long it takes? Okay, so Sebem. So you said all this, but why does the fund rate have to go to 6% then? I mean, you know, the pandemic and Russian War effects are fading. They're in the room. Yeah. Inflation's coming in.

Feels pretty good. You know, all the trend lines look good. The things you can forecast in inflation with some certainty, like the cost of housing services or vehicle prices, we know they're coming in. So why? No, it may not. It may not have to. But this is about my complicated thing.

Because if you try to guess at the, okay, not get, if you try to estimate the terminal rate and when you stop, based on your one sector aggregate Phillips score model, you cannot get an exact. No, no, no. But that's. Okay, but you and I understand. We're on the same page.

Obviously, the Phillips course is not pertinent here. I mean, we get right at three and a half percent on an employment rate for a year and a half in inflation coming in. Okay, but this is why, okay. But Mark, now let me push back. This is why I said it's complicated because complicated means you have to be thinking about sector of this career. If you start thinking about sectors of there, there, you know, even like you do a fairly, you know, decent aggregation, you are going to be dealing with 66 sectors in the United States economy. You open up globally, this is going to explode, right?

And you are going to now think about those, you know, 66 Phillips girl. This is complicated. And it's complicated in the sense that you're trying to estimate an I have a number based on that. Okay, fair enough. Okay, fair enough. That is complicated. 66 times 73. Exactly. All I know is it feels like inflation's coming in as the supply shocks begin to change.

No, you're exactly. So we may not have to go to six. We may not have to go. But this is exactly what they are trying to, right? They never wanted to do more than they needed. But at the same time, they want to do enough that they wouldn't be in a position of, oh, we didn't do enough. And the risk of that, having the inflation, messing up the inflation expectations.

and becoming sticky is bigger, right? So this was the very delicate dance they were trying to do the last 15 months. And we might stay at 5.25.5, Mike. And this, again, goes back to data-driven policy, right? Now, this data came out great this week. The next piece of data coming like that, so we are in the right trend, they are going to stay. They are not going to go to six.

But this is exactly what I think they mean the data-driven policy-making. Well, I'm all in on data. We're big fans of data. In fact, I think you're, you use a lot of our data, Orbis data, so that's our data, by the way. Yeah, I know. I'm a big fan. We're all in on data. We're going to bring it on, baby.

I want to, I think we've taken enough of your time. I really appreciate you coming on the podcast. I'll have to say, I feel a lot better. You know, I actually was still am, but I'm a little less concerned about the banking system. I feel like that could still be an issue. and I'm glad we're on the same page. And the listeners should know, I didn't know what your view was on inflation before I had you on, but it was glad to hear it. But I really do appreciate your optimism and, you know, I'm very sympathetic to it.

So thank you for coming on. Thank you so much. This sounds great. Thanks, Mark. I appreciate that. And with that, dear listener, we are going to call this a podcast. Take care now, everyone.