Moody's Talks - Inside Economics - Bonus Episode: On the Road to Recovery

Episode Date: October 5, 2021

The Delta-variant of COVID-19 has damaged the economic recovery, but we remain optimistic the economy is on track to return to full employment by spring 2023. What could derail this optimism? Could the economy perform better than anticipated? What is the long-term economic fallout of the pandemic?The episode's slides can be found here. 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.

Hello, everyone. Thank you for attending today's webinar. I'm also joined today by one of my colleagues, Chris Duretti. Chris is the Deputy Chief Economist, and he's graciously agreed to curate your question. So feel free to fire away on the Q&A, and he'll pose those questions to me towards the end of the conversation. In fact, I'll speak for about 40, 45 minutes. this go through some slides and then we'll go to your questions and comments. So looking forward to that.

And thanks, Chris. As many of you may be aware, Chris is one of, along with Ryan Sweet, one of my two colleagues that join me on Inside Economics. It's our podcast that we've been doing now. Hard to believe Chris, but I think it's like seven months we've been doing it. And we do it every week. And Heather, who's producing today's webinar, indicated that if you go to the resource button, you should see a resource button, you'll find a link to Inside Economics.

So a lot of what we're going to talk about today on this webinar, we chat about on the podcast as well. But thanks, Chris, for participating. Appreciate that. Okay. Okay, to the show, to the webinar, it's very simple, two parts. Part one, I'm just going to give you a sense of the baseline outlook, the most likely outlook for the economy in the middle of the distribution of possible outcomes. This is our baseline.

And then I'm part two going to turn to the risks, and I'm going to focus mostly on downside risks. I think that's still apropos, but I'll end on. on a positive note on an upside risk, just to round things out a little bit, then we'll turn the QA. Okay, so let's just dive in the baseline. I think this first chart nicely shows where we've been

and where we're headed, or we think we're headed, again in the middle of the distribution of possible outcomes. This is the employment jobs, millions, going back to the start of 2019 monthly data, all the way through the end of about 2024, so I'm giving a few years of forecast as well. You can see the recession, the pandemic, COVID-19 recession,

very severe back March, April of last year. We lost 22 million jobs. Unemployment got to about 15%. Pete de Trotrop declined in GDP, real GDP, the valuable things that we produced was about 10%. So 10% peak to trough. For context in the financial crisis, which I thought was a doozy back a little over a decade ago. Real GDP, Pica trough fell about 4%.

So kind of gives you sense of magnitude. We've been recovering ever since. A lot of it driven by the massive monetary and fiscal policy support. The Fed is obviously very aggressive in early on in providing various credit facilities to keep the financial markets operating, lowered short-term. term rates to the zero lower bound, engaged in aggressive quantitative easing, bond buying to keep long-term rates down. And on the fiscal policy side, that got all in, by my calculation, just over $5 trillion

in fiscal support, beginning with the CARES Act back in March of 2020 and extending through the American Rescue Plan, which was passed into law under President Biden in March of 2021. A lot of other support provided along the way, but $5 trillion or 25% of GDP roughly in total. Again, for a little bit of context back in the financial crisis, if you took all the fiscal support during the crisis and immediately after, before policy turned to austerity, the support that, then was about 10% of GDP, so a lot of support. You can see where I think things are headed. Forecast is the shaded part of the chart.

A few key assumptions here. First, that we've achieved what I'm calling herd resistance. This doesn't have any kind of official definition. I'm just using this as a way to describe the assumption that the pandemic is, you know, obviously still raging, but it is, slowly winding down that each new wave of the virus is less disruptive, at least from an economic perspective, than the previous waves. So the delta wave that we've been suffering through is, it's been disruptive and I'll come

back to that in the context of the risks, but it's done less, it's done economic damage, but it's done less economic damage than the wave that struck back at the start of this year and obviously the initial ways of the virus when there is so much uncertainty. So I'm assuming that this is a key assumption that the pandemic steadily winds down. Vaccination rates continue to increase, get more therapeutics,

figure out how to mitigate the virus. It's not going away, and there'll probably be more waves, but they'll be less disruptive. I'm also assuming more fiscal support to the economy some variation of what's being debated in Congress. Currently, the Biden build-back better agenda kind of on the table

is a $550 billion 10-year public infrastructure plan and then a $3.5 trillion that's called a social infrastructure plan that it's a range of support for different social programs from education to housing to health care to child care to climate change. The $550 billion package that has bipartisan support,

the $3.5 trillion social infrastructure package will be done under reconciliation with only democratic votes. Now, you know, I don't think that entire package is going to ultimately get through. So we're assuming the $5.50 billion package does and $2.5 trillion reconciliation package finally makes its way through the legislative process, gets signed into law by the end of October going into November,

and it's implemented in early 2022. And that does provide some support to the economy, beginning in late 22, going into 23, particularly in 24 and 25, that's the peak of the impact from that plan. And it also helps to support longer-term economic growth, which I'll talk about in a few minutes in the context of the risks. In terms of monetary policy, the support is now starting to fade. The Fed ended its credit facilities towards the start of this year. It's just about ready to begin winding down as quantitative easing, the so-called tapering QE.

Looks like that probably will begin in November. They're buying $120 billion every month in Treasury Securities and NBS, mortgage-backed securities. That'll get wound down steadily and come to an end by kind of this time next year. And then if everything sticks to the script, certainly the script I'm showing you here, The Fed will begin to normalize short-term interest rates just about the time the economy pulls into full employment. And you can see in the chart, that would be in our baseline sometime early 2023. Full employment would be something consistent with the unemployment rate in the mid-3s, kind of sort of where we were pre-pandemic.

and somewhat higher participation rate. Pre-pandemic, we were well over 63% limited to participation. I don't think we're going back there just because we've got a lot of boomers retire early and they're not coming back, I don't think. So full employment would be consistent with a participation rate that's probably just south

of 63%. But we expect that by early 2023. Just as a point of interest, to get from here, to there by early 23, that will require the economy to generate something like a half million jobs every single month on average. Some months, it will be softer like last month because of Delta.

We only got 250,000 jobs roughly the month before that. In July, we got a million jobs, but that was before Delta. So, you know, I think there's going to be some ups and downs and all around here, thus the winding road to recovery, but about a half million jobs per month. Just to round things out on the baseline. I know there's a lot of interest in the path for long-term interest rates that is also critical to the outlook. And here there's a, you know, obviously forecasting anything is tough, but forecasting

long-term interest rates is particularly intrepid, but here it goes. The 10-year-terury bond today is sitting up about 1.1. We expect a little bit for more at once a few weeks ago. We expect the 10-year treasury yield to end this year at 1.75%. I'm rounding, obviously, but, you know, orders and magnitude. 2.5% by the end of 2022, 3% by the end of 2023. And by mid-decade, when the economy is in full employment, inflation is at defense target.

the world's economy's in equilibrium, let's say, the equilibrium 10-year-turgery yields should be about 3.5%. So that's where I think it's going to settle in. His fund rate will be closer to 2.5%, so you have a spread between the two of about a percentage point, about 100 basis points. If that's the path for rates, that does suggest that the yield curve, the difference between long rates and short rates, will, become even wider here over the next 12 months. So for a lot of you in the financial system where yield curves matter, in terms of margins and profitability,

I think you'll be able to enjoy a somewhat wider yield curve here. Okay, that's the baseline, most likely scenario. I do want to say one more thing about the baseline before moving on to the risks. and that is there will be some longer-term consequences and, you know, I run the risk of over-hyping the Inside Exxonics podcast but here goes. Last week, in the last week's podcast

we did talk about some long-and-term consequences of the pandemic. I think, Chris, you focused on demographics, very important impact on demographic turns. Ryan, focused on debt, sovereign debt and corporate debt globally, nervous about the increase in indebtedness and what happens when interest rates do rise. Again, I'll talk about that in the risks.

And then I talked about remote work, and I do think this is a very significant shift, long-term consequence of the pandemic that has all kinds of economic implications. And you can kind of get a sense of that here in this slide, which shows net out migration from urban cores across the nation's 400 plus metropolitan areas. This is monthly data, going back to the start of 07. The last data point is for August. This is based on credit file data.

We get a 10% sample, random sample of all credit files in the country from Ethical FAC every month. And it's anonymized. obviously, but we can see addresses, and so we can look at address changes. And based on that data, we can identify, you know, where people are moving from and moving to. And the shaded part of the chart represents the, when the pandemic, the pandemic, when the pandemic hit. And if you look pre-pandemic in the 12 months leading up to the pandemic, net out migration from urban cores. that's the number of people moving out of urban courts to suburbs, exurbs,

and rural areas less the number of people moving into urban courts, was somewhere south of 300,000. Currently, as of August, again, the last data point, 600,000, so more than a doubling in the net out migration. And you can see in the chart the top 10 areas that have suffered the biggest increases in net out migration during the pandemic, No surprise of New York and a number of other major areas in the Northeastern Corridor, Boston, Philly, our hometown, and D.C. On the West Coast, the big California metro areas, L.A., San Francisco, Seattle, I think Miami is in there.

Yep, there's Miami, Chicago. And you'll notice that it looks like the net out migration is topping out. But the other thing you'll notice is it's not really. really rolling over, so it remains very elevated. And I think that does go to the increasing prevalence of various forms of remote work. And I do think as technology improves and HR departments figure out how to empower remote work,

we'll see more of it. Given how tight labor markets are and white leader remain, given demographic trends growing forward, even on the other side of the pandemic, I do think workers have kind of the upper hand here in negotiations with our employers, and one of the things that are going to demand is the ability to work from, you know, wherever they want to work. So this is a trend, a phenomenon that's here to stay. It has obviously important invocations for regional economies, so these areas shown here in the chart.

They suffer as people leave, and then, of course, the areas where they're going benefit, So folks in the Northeast are going to Atlanta and Charlotte and Tampa and Jacksonville and Orlando and Austin. And folks leaving Seattle and the Bay Area in L.A., they're moving to Boise and Phoenix and Tucson and Vegas and Denver and Salt Lake City. So those areas really benefit. And you can see it in the employment data. You can see it in the House Price Data and Housing Demand, which will come back to it a few minutes. So I do think the pandemic, as they say, will have a long tail, and one aspect of that long tail will be increased from over. Okay, that concludes part one, the baseline.

Hopefully you've got a pretty good sense of it. I think fair to say that optimistic about the economy's prospects. in fact, just to strike that point home, between the time when the pandemic hit to when the economy returns to full employment, gets back the full swing will be about three years. So got hit early 2020 with back to full employment by early 23, three years. Typically, if you look at business cycles since World War II, it takes about six, seven years for that to happen. And, of course, in the expansion after the financial crisis, it took us almost 10 years to get back. A lot of scarring after the financial crisis, not so much after the pandemic.

So it's a relatively upbeat, optimistic baseline outlook. Now, however, being the good economists that's tried to be, there's obviously a lot of risk to this. So, you know, part two, what could go wrong? And just to kind of encapsulate, there are obviously many risks, but just to kind of put it into some kind of relief in context, is this what we call risk matrix. This is for the United States. We do this for many countries around the globe,

varies country by country, but this is for the U.S. Just to acclimate yourself to the matrix, the X-axis, the horizontal axis is the severity of that risk for that shock. And this is kind of like a, there's time dimensions of this, too. It's kind of like a present value of the expected loss if the shock were to occur. So if it's a severe shock and it's more likely in the near term, that's a big deal. So for example, the Treasury default, you can see that all the way to the southeast part

of the matrix, that, you know, while that has a low probability of it happening, and that's the horizontal axis. It's the severity that shock would be very, very significant. You know, I'd even put in a category catastrophic if the US government actually defaulted here, and we'll come back to that in a minute and under the risks. The, as I mentioned, the horizontal, excuse me, the vertical axis is the likelihood of the shock,

you know, obviously very subjective. So you look at the kind of the northwest of the matrix forbearance cliff. This is hearkening to the fact that many of the government supports that were provided during the pandemic to help borrowers and debtors kind of manage through are expiring. There's a mortgage forbearance for borrowers of FHA, VA, NADD-A, NANI-Freddie loans.

That's starting to wind down. There was student loan payment forbearance. I believe in her current rules, that's going to expire in January. There's moratoriums on foreclosure for those government-backed loans. And, of course, the rental eviction moratorium. That ended about a month ago now when the Supreme Court ruled that the federal rental eviction moratorium was unconstitutional. So that has ended. If you go back, I don't know, six months, certainly 12 months ago, I would have thought the forbearance-cliff,

was a much more significant risk to the economy. Many more borrowers, households were under financial pressure. And if they hadn't gotten that support, we would have seen many more credit problems, many more foreclosures, many more flaws, and that would have more economic damage. But at this point, much less so, we've kind of worked through a lot of the problems

and people are getting back on their feet financially. So this clip is going to happen, so very high probability, but the severity of the shock is very low. Finally, just the obvious is in the northeast part of the chart. The biggest, most significant risk with high likelihood and high severity is, well, we're going to have another way over the pandemic. That feels like the message we learned from Delta. And unfortunately, you know, if you go back when the vaccines were being rolled out earlier this year, there was a lot of optimism. And I was optimistic myself, you know, thinking that perhaps this was the end of the pandemic,

we'd not suffer any more material waves of the virus or the delta wave putting it into that hope. And I do think it's appropriate to think that there will be other waves of the virus. Again, I'm assuming in the baseline that each wave of the virus is less disrupted to the economy than the preceding one, but, you know, obviously a lot of risk around this. So I'm not going to go through all of this, and it's changing very rapidly because if government's shut down there and that's already changed since I did the chart. So, you know, there's a lot of – this is moving all the time and evolving, so I'm not going

to go through at all, but if you have any questions about it, you know, feel free, I suppose so. Okay, so let's dive deeper into some of these risks, and I'm going to go through a handful of downside risks. And again, as I mentioned earlier, I'm going to end on an upside one just to, because there are upside risks. I think it would be therapeutic and on a positive note and consistent with the overall message of this webinar. Risk number one, the pandemic. It's, you know, it's still raging, still doing damage. The Delta wave variant of the virus has done damage. You can see that in lots of different ways, one of which I'm showing you here.

It has impacted sentiment, consumer sentiment. I'm showing two measures of consumer sentiment. The blue line is the conference board survey of sentiment. The green line is the University of Michigan survey of sentiment. This is monthly data going back to 20. 2019, start 2019, and we got the September value from the conference board. I haven't gotten it yet for University of Michigan, I don't think. Or no, maybe we did since I did this chart, and I think it kind of, it's kind of very

consistent with the last data point here, maybe a little, proved a little bit, but the, but the broader point is you can see that sentiment got not surprisingly crushed when the pandemic hit back in early 2020 had slowly. recovered and then Delta hit and cinnamon has fallen off quite significantly. Interestingly enough, the University of Michigan survey, at least for August, that was a pandemic low. The conference board survey is held up and has done better. Some of that goes just to the types of questions that are asked in the surveys.

The conference board is more labor market oriented and labor markets have performed very, very well. And the blue line has done a little bit better than the green line, which is more around personal finance issues. But both show that Delta has spooked consumers going back to my point that people were hoping that with the vaccine, this thing was over, but those hopes have been dashed. You can also see it in spending. The impact of the Delta variant on spending, air travel has fallen back a bit, restaurant,

bookings are down a bit. You know, people have pulled back a little bit on getting out there that more people have been sheltering in place. You can see the supply chains. Obviously global supply chains have been severely disrupted by the pandemic and they're just now more jumbled as a result of Delta. Delta really nailed Asia, particularly Southeast Asia, and a lot of the supply chains begin there, particularly the chip industry.

You know, a lot of chip plants in Malaysia, for example, they had to shut because workers just were too sick. various ports of terminals and ports in China who shut down because the Chinese have the no tolerance policy with regards to the pandemic and shut things down. And that really is further exacerbated. The supply chain issues created more shortages, disrupted the vehicle industry.

There's simply no inventory and that's curfing sales. They're hurting the construction industry home building because of building materials and appliances. So it's really hurt, you know, significantly. Put more upward pressure on prices, adding to inflationary pressures, which I'll come back in the minute. But, you know, the risk here, and, again, my assumption is that the pandemic will continue to wind down,

but the definitive risk is that the next wave is actually more of a problem. You know, it's more contagious, more virulent, is, you know, obviously if it alluded our vaccines, that would change the ballgame here. So, you know, risk number one is the pandemic itself. Risk number two is fiscal policy. Got a little bit of good news. In the last week, the administration, Congress, came to terms on providing short-term funding for the federal government so that it could continue to operate for a couple more months before it needs more funding.

avoiding the government shutdown. But two things on the docket here that you get ironed out pretty quickly. The first is the debt limit, and there's a lot of brinkmanship around this going on. I don't know if you're following what's going on in D.C., but Republicans and Democrats are really battling over this debt limit. Republicans are insisting that the Democrats figure out a way to increase the death limit on their own. Democrats are arguing that they can't do it at least not without the Republicans

kind of stepping aside and not filibustering efforts to suspend the debt one. Republicans are insisting that Democrats can that can include it under the reconciliation legislation, passed it. In that case, they have to, because of the reconciliation was only, they can only increase that they can't suspend it. but they could do it on their own with only Democratic votes.

So the brinkmanship here is very high. And breakmanship around the debt limit is, it does damage. You know, it's not costless, even though at the end of the day, lawmakers have at least historically figured out a way to increase the deadline. You can see that here in this slide. This shows the four-week U.S. Treasury yield, the trade yield on U.S. Treasury securities, one month the T bills.

Back in the 2011 debt limit kerfuffle and then in the 2013 curfuffle, T is the drop dead date for raising the dead ceiling. So you can see in the period leading up to that drop dead date, T bill yields rise because the folks that had that four-week bill are pricing in the probability that they may, not get paid on time and then it would, you know, wreck their

return, and so they jack up the yield as you approach that drop that date. Same thing is starting to happen now. I think yesterday the four-week T-bill yield had risen about seven, eight basis points from

where it was just a couple weeks ago. So not quite to where we were in 2011 or 2013, but my guess is we'll get there because I don't think lawmakers are going to nail this thing down until we get to drop that date. Now, there's a lot of uncertainty around exactly when that's going to occur. Janet Yellen, the Truder Secretary, is identified October 18th.

CBO says no, probably later in the month, maybe even as late as early November. We're estimating, Bernard Yaros and I did a paper on the debt limit that you can find if you go to Economic View or you Google it and Sandy that point you'll find that the drop dead date is October 20th. There's some big Social Security payments due on that date. But

because of the uncertainty around the timing of when the Treasury receives its tax payments and outlays because of the pandemic, the scrambled kind of timing of outlays. And of course assistance related to Hurricane Ida and other

and fires. the federal government assistance buyers, hard to know when checks are gonna get cut, so that makes things very complicated. Now, my baseline here is obviously that lawmakers will settle this in time before they actually, the government actually default, probably through the reconciliation process.

But I'd have to say there's not any consequential risk here that there's a misstep and we might actually see it default. You know, if it's a day or two, I think we see turmoil and market and that would be required to get lawmakers to act quickly, which I think they would. But if they don't act quickly for whatever reason, they get bogged down and, let's say this thing drags on to November or so, like Thanksgiving or say, that's kind of the scenario we considered in the paper I mentioned. That would be the fodder for another recession, so, you know, a lot of risk around this.

The other aspect of what's going on in D.C. is around the Build Back Better agenda. And I mentioned this earlier, a lot of different scenarios on how this may play out. And to give you a sense of what it means for the economy under these different scenarios is the unemployment rate, which I'm showing you here. This is quarterly data from Q1 2019 through the end of 2024. You can see where I think full employment is. As I mentioned earlier, that would be consistent with an unemployment rate from the mid-3s. This is based on simulations of our model of the economy, the global economy, or macro economy.

The blue line represents the unemployment rate if there has been no additional policy under Biden. Let's assume no American Rescue Plan, that's the plan, the $1.9 trillion support package that got passed in March of 2021. You could see if we had not gotten the ARP, the American Rescue Plan, the economy would have struggled this year. Unemployment would have hovered around high in the high five close to 6%. It would ultimately have fallen as the pandemic wound down, but it would have been a more painful kind of scenario. The red line represents the unemployment rate if no additional support supply. So we got the ARP to help push unemployment down.

We're now at 5.2% on the unemployment rate. But, you know, what if we don't get any additional support? You can see it kind of goes sideways here, in terms of unemployment, and you know, the economy doesn't get quite across the finish line to full employment. The green line, that represents our baseline, so we get, we had the American Rescue Plan,

the ARP, we get the $550 billion infrastructure plan, that's bipartisan, and then we get a $2.5 trillion reconciliation package, that's the social infrastructure, and that kind of lands the playing the economy right on the tarmac. The Green Line kind of just goes to full employment, and that's the optimistic baseline scenario that we have. By the way, the $2.5 trillion is kind of the midpoint of the current $3.5 trillion

on the table and the $1.5 trillion that the moderate Senate Democrat Joe Manchin from West Virginia said he's willing to vote for. So I'm assuming that, you know, $3.5, $1.5, compromise is $2.5. At the moment, it feels like it might be a little smaller than that, you know, closer to two. But we're still assuming 2.5. We are assuming some pay for us here, some tax increases on large corporations and kind of rolling back some of the tax cuts for the large corporations and the well-to-do. High-income, high-net with households that will pay for, of the $3 trillion in total support, the $5.50 billion infrastructure of the $2.5 trillion reconciliation, roughly $3,000.

trillion, we're assuming about $2 trillion of that is paid for. So that's a budget deficit. These are all over 10-year periods, budget horizon at the CBO. These are budget deficits of about a trillion dollars or about $100 billion per end. But the green line is kind of the optimistic baseline. I did, though, run this scenario where we get what's on the table now, the $3.5 trillion. You can see that's the gray line. line, the unemployment rate actually falls through the full-employment unemployment rate,

and I would say that that does run the risk of generating inflation that is uncomfortably high will cause the Fed reserved to tight monetary policy more than we're anticipating, and that is the fodder for a more kind of classic business cycle, you know, an over-heeding economy. So I do think, you know, lawmakers do have to essentially spread a needle here. They don't want it to be too small, but they don't want it to be too big either. Otherwise, you know, you run the risk of overheating. I will say it, I didn't show it here, but I do think the infrastructure plan and reconciliation package if passed will help to support longer-term economic growth.

The infrastructure plan mostly through somewhat stronger labor productivity. It's small, but, you know, small positive. And the social infrastructure plan around higher labor force participation, mostly because it provides support for child care and elder care and disability and pay people which is helped to support higher labor force participation, particularly among female workers and lower income households of families of color where participation rates are relatively low. So it does provide some long-term benefits.

Of course, the climate change does address an issue that I do think is kind of a significant longer-term implications for the economy. But nonetheless, a lot of risk around that. So that's risk number two. Risk number three is inflation. I'm not going to dwell on this. You know, I am assuming, expecting that inflation will moderate, that it is transitory, as the Fed would say, that it is related to the pandemic.

As a pandemic winds down as I anticipate, global supply chains start to operate. iron themselves out because of the higher prices. Businesses respond by ramping up capacity, investing more, which they appear to be doing. I take a little bit of time, but by this time next year, certainly as we move into 23, inflation moderates and close to the Fed's target, which is for the core consumer expenditure inflator inflation, excluding food and energy prices, be just north of 2%. And I think that's where we settle, you know, roughly by the spring of 20%. But, you know, obviously a lot of risk around that.

You know, in addition to the pandemic, I could be overly optimistic about how quickly these supply chains, you know, kind of work things through. I could also be overly optimistic about how quickly the labor market kind of adjust. There's 11 million close to open job positions, and that's a record by rumors of magnitude. magnitude you have to go, even before the pandemic when the living worker was tight, we had six and a half, seven million open positions. So we got to fill those positions, and if we don't, then that means higher wages and higher inflation than I'm anticipating. Now, again, I do think the pandemic is behind why it's taking longer for workers, available

workers, in and out of the workforce to take those open positions, you know, taking care kids taking care of health of the family members worried about getting sick, you know, there's a lot of issues related to the pandemic and that they'll iron themselves out as the pandemic winds down, but, you know, a lot of risks around that as well. So inflation could be more of a deal than I'm anticipating. That's risk number three, downside risk number three. Downside risk number four is asset prices. They're juiced up.

They're pretty lofty. Evaluations are high. You can see that in the equity market here, the stock market. This is my favorite measure of valuation. In the stock market, this is kind of like an economy-wide price earnings multiple. The numerator is the value of all publicly traded stock that's measured by the Bullsher 5,000. The denominator is economy-wide corporate earnings. I got data back for the start of 1980.

The last data point is for the second quarter. Excuse me. Yes, excuse me, for the second quarter of 2021, a little bit lag. And you can see the PE multiple by this measure is back to where it was in late 90s, early 2000 Y2K. Y2K, that was a bubble. I don't think there's any debate about that. I don't think the current high valuation signal a bubble today. I mean, there is speculation creeping into the equity markets and asset markets more broadly.

You know, game stock, mean stocks are all symptomatic of that. But, you know, valuation should be high. given how low interest rates have been and how low they're expected to remain. But regardless, I think valuations are high. And I do think the correction, you know, stock prices have gone kind of sideways here for the last several months, in part because interest rates are starting to push a little bit higher. I do think in our baseline we have stock prices essentially going to stay flat here for another year, 18 months, let corporate earnings catch up, you know, let it adjust to the higher interest rate environment

that I'm anticipating, but I do think there's a lot of risk around this. We could see a much more significant correction in equity prices for a much more sustained basis, and that could do some damage to the economic recovery that I'm anticipating. As I mentioned, other asset prices are reduced. In addition, equity prices, the fixed income markets are used, credit spreads, and the bond market are very thin, obviously what's going on in the crypto markets,

And then, of course, the housing market is also really, feels really juiced up. You can see that here in this map of the country that's for the 100 largest metropolitan statistical areas across the country. Here, what we've done is calculated price to rent ratios. Again, kind of like a price earnings multiple. So the price of the home in the numerator, the effective rent in that area, in the denominator, in the long run the price-to-rent ratio should be roughly consistent with its long-run historical norms, which varies quite a bit by market for lots of different reasons.

What I've done here is for those areas where the current price-to-rent ratio is consistent or within 10% of its long-run historical norm, I'd say that's appropriately valued. They're in green. Those are metropolitan areas that are in green. So my home, Chris's home in Philly. You can see where Philly is. That's in green, our home is appropriately valued at least by this measure. If you're area in orange, you're somewhat, your PR ratio, your price rate ratio is about 10 to 20% above historical norm.

So you're overvalued if you're in red, well, seriously overvalued more than 20% by this measure, mostly in the west and parts of the south. This is not meant to be, you know, an indicator that's proved positive. It's, you know, I wouldn't rely on this by itself, but this is a good kind of screen. If you're an orange, certainly in red, it's saying, hey, come look at me, what's going on? Is there a reason why that, you know, prices are all juiced up relative to rents by historical norms? nationwide, it does feel like prices are, again, I would call it, there's not a bubble, it's not speculative, you don't see the kind of flipping that we have

historically the lending, the mortgage lending has been very responsible. Credit scores on mortgage loans will remain very high. So I don't think this is anything comparable to what we saw the state prior to the financial crisis. But nonetheless, as interest rates rise, I think some of these markets, particularly the red market, are at significant risk of, if not prices going down, certainly going flat for a while, and as you expect, some price to climb. So something to watch.

I don't think this is existential by itself to the economic recovery, but it is a big enough risk that it could change the contours of the economic recovery, certainly some of these markets around the country. Finally, risk number five, downside of risk number five, the increase in debt, particularly sovereign debt,

governments across the globe have followed the same policy prescription, borrowed a lot of money to help support their economies. And I do think with the leveraging up as interest rates do normalize and rise, that

will create some problems and we could see some real stress fault lines in sovereign debt. Similar kind of dynamic and corporate debt, not everywhere. I don't think that's as big an issue here in the U.S. Although, you know, something to watch, the leverage loan market has been very active.

But it's a much bigger deal in other parts of the world like China. Just to explain this chart, the X-axis is the debt-to-GDP ratio for sovereigns as of the fourth quarter of 2020. The Y-axis is the so-called concept of fiscal space. That's a difference between the actual debt-to-GDP ratio and that debt-to-GDP ratio that we estimate. to be above which investors begin to lose state that they're going to get paid in a timely way,

jack up interest rates to get into this kind of self-reinforcing negative cycle. You can't see a number of countries in the emerging markets, you know, Russia, United Arab Emirates, you know, some developed economies

you can see Spain, Italy, you know, Japan, very close to that zero fiscal space line. So that means that, you know, some of these economies are at significant risk of suffering some kind of event, maybe even a crisis, sovereign debt crisis, you know, as rates rise.

Not, I don't think this year, next year, but as race normalized towards mid-decade, this will become, I think, more of an issue. Finally, let me end on a positive note. I said I would. And I do want to highlight what I consider to be the most meaningful upside risk to the outlook. And that's productivity growth. I'm showing you non-farm business productivity growth here, quarterly data back to 1990. Last data point is the second quarter of 2021.

The blue line represents the year-over-year growth in productivity, the five-year, the green line, the five-year annualized growth just smoothed out the volatility if it's an underlying trend. You can see that productivity growth really did slug in the expansion after the financial crisis. crisis, different context between World War II and the financial crisis, non-farm business productivity grew about 2% per am, almost on the nose. You know, some times a little stronger, other times a little weaker, but on average 2%. And the expansion after the financial crisis, the decade after, it was about 1%. But look at it now, it's been migrating higher, it's closing on 2% again. Now some of that may be just cyclical, some of it may just be measurement.

You can see during, you know, when you come out of recession, like you did after the financial crisis or after the pandemic, you get this pop and productive growth for various measurements in actual more fundamental reasons. So there may be a cyclical in this of what's going on here, but it does feel like things are improving. Businesses are investing very strongly. They did so in the pandemic and post-pandemic that investment remained strong. A lot of it's towards labor-stating technology because I do think businesses realize that there's going to be, you know, severe labor shortages going forward. And in our baseline, we're assuming that productivity is improved from about the 1% pre-pandemic

in the post-inational crisis period, so about 1.5% per annum. But, you know, I do think there's a risk here, upside risk here, that it could be back up closer to the two. And I think there's some good fundamental reasons for that. We can go into that if you're interested in the Q&A. But if that's the case, if it's 2%, that's a big deal. That has a lot to say about future income growth, the profitability, asset price returns, our ability to address our fiscal issues, where interest rates are going to land.

I mean, enormous implications. So something to keep an eye on, and hopefully we get that positive surprise. Okay, I covered a boatload of ground. I took exactly 45 minutes. I am going to stop and turn the conversation back to Chris. And Chris, I'm hoping that we've got some questions from the group. Yeah, we sure did. We have some great questions.

Keep flowing in, so do encourage audience to keep asking away. But let's see how many of these you can get through. And I'll take up with your last line, one of my favorite topics is productivity. And where the question has came in regarding reshoring of manufacturing production to the U.S. And I wanted to get your thought on that. You expect to see that continue or accelerate or slow down or we followed the productivity and the trade picture of going to shake out over the next few years. Yeah, great question.

And I would say to preface, Chris, you and one of our other colleagues, Dante Di Antonio, wrote a good paper on productivity growth. and it was kind of a counterpoint and I think you were arguing that for the upside surprise here and Dante from the downside surprise, is that right or it was the other way around? I can't remember.

No, that's right. That's right. That's right. That's right. I'm the technopauseus. They're a technopauseus, right? Yeah. You know, I think there's many elements to this and one of which is you know, I do think we will see reshoring

continue. I do think American businesses, I think businesses all around the planet, are we evaluating their supply chains given what they have been going through and what they're still going through? Those supply chains are very, very long and very vulnerable, as we can see. And, you know, it's not just the pandemic. There's been other events that kind of highlight this risk. I mean, the earthquake in Japan back in 2011 that significantly disrupted the

auto industry, for example. If that was the end of the story, I think most companies would have ignored it, but you know, you throw in the pandemic, and I think you know, it just strikes on the point that supply chains are long,

they're at risk, they're very vulnerable, and can lead a significant disruption. Also, adding to this is the growing tension or the very high level of tension between the United States and China. And, you know, it seems to have abated a bit under President Biden.

President Trump obviously took a very combative approach. President Biden has not stood down and has continued to maintain the higher tariffs that President Trump put into place and, you know, continues to, you know, engage China quite aggressively, a little less publicly and a little less combatively. But I think everyone now has the view appropriately so that this relationship, is a bit vex not going to iron itself out quickly and does pose risk to supply genes that go into Asia. And then, moreover, the administration and Congress have seen what happened with supply chains and view it as a, I think, again, appropriately so, as a national security issue,

particularly when it comes to things like semiconductors and chips, because that goes into, you know, all kinds of everything, you know, including military equipment and sophisticated satellites and instrumentation and critical to national security, sophisticated materials and machinery also, you know, very important. So I do think the Congress administration, as part of the build back better agenda, you know, or appropriating funds now, you know, harden these supply chains and bring them in. So I do expect manufacturers, U.S. manufacturers and others, to retailers and wholesalers, to shorten up the supply chains, bring them in, reevaluate them, and I do think that will be a significant shift here going forward.

And I do think, you know, it is an element of, you know, the expectation with that investment that we will see some improvement in productivity. I don't get to the top of the list of reasons why productivity growth could surprise on the upside, but I think it's on the list of reasons. All right. Great. A question about the Great resignation. And in your opinion, is this a short-term phenomenon or is it going to linger? I think there's a both a cyclical near-term and a secular long-term element to what's going on in the labor market, labor supply issues. On a cyclical basis, I do think the pandemic has really scrambled things.

That, you know, if you look at the reasons why people that are unemployed or who stepped out of the work for a certain pandemic are coming back slowly, and you can get a good sense of this by looking at the Bureau of Census Household Pulse survey, a survey that's conducting on a bi-weekly basis more or less since the pandemic hit. And it's a great survey, very large, and asked lots of questions, and some of the questions are around, you know, if you stepped out of the workforce during the pandemic, why? And you can see there that, you know, at the top of the list are taking care of kids. Child care, big issue.

Now that's maybe less of an issue today than it was a month or two ago because the school's reopening in person, but, you know, child care is still an issue, you know, for people, and schools still are struggling to stay open because of the delta variance in the pandemic and the infections. Taking care of elderly parents, fearful of getting sick, taking care of sick family members or friends, you know, all those things are playing a role. And, you know, it's not until the pandemic really winds down in a more significant way. hopefully we don't have another wave and if we do, you know, it's clear that it's not that, it's not going to be as virulent or contagious or disruptive and people start going,

you know, coming back in and going, going back to work and taking those 11 million open positions. So I said, I did mention that I thought it was going to take about a year, maybe 18 months for global supply chains to write themselves. I suspect it's going to take about a year, 18 months for labor markets to kind of work through all these issues and kind of normalized, take this over the position. I do think there's a secular element here, though, too, and that is, and this is what you're talking about in the podcast around demographics, that even pre-pendemic demographics were arguing

for very tight labor markets. I mean, the baby boom generation, large cohort is leaving the labor market quickly. It left, you know, significantly during the pandemic, and those folks aren't coming back. You know, they were probably going to only to work another year, two or three, anyway and the pandemic just accelerated all that. And with stock prices and mounting values where they are, you know, I think many feel, boomers feel like they have the financial whirlpool fall to retire. So they're not coming back.

And then, of course, immigration, for immigration, significant important source of supply, but skilled and unskilled, that was under significant pressure even before the pandemic because of shifts in policy under the Trump administration. and, of course, the pandemic has just crushed, you know, immigration. I do think it will start to normalize a bit under President Biden, at least the last one more immigrants have come in, but, you know, I don't think we're going, it's going to be tough to get back to the kind of immigration we had pre-President Trump

just because of demographic trends, you know, overseas, a population growth has slowed very dramatically, and once population in a country falls close to the replacement, rate, population growth. Immigration just falls off very rapidly, and that's happening in more and more countries, emerging markets across the world. So I do think there's a, you know, a very significant, secular, long-term issue here with regard to labor supply.

I think the pandemic is going to mark a, at least in our timeline, in our minds going forward, a shift in the balance of negotiating power between workers and their employers, you know, for the up until 30 years, 35 years between late 70s, the late, excuse me, excuse me, late 1970s, early 80s through the pandemic. It was a employer's market. I think going forward, at least for the next decade, perhaps two, it's going to be a workers market,

a very, very different kind of environment. All right. All right, I'm going to give you a tough one. I have the last question here. Sure. Question. Question about your employment assessment or employment impact assignment of the billed back better package.

So whether it's a 2.5 or $3.5 trillion package, certainly that's going to provide a lot of benefits, perhaps in terms of long-term predictions you as you mentioned, but there are also a number of disincentives or potential incentives to work, right? Higher taxes, benefits going to things of individuals that might cause benefits. provide less neighbors from the market.

So a question how did you came up with this conclusion that employment would actually increase increase rapidly and then a corollary to that is looking at the at the pre-pandemic employment situation, right? We had high participation and the rate was coming down, our influence was coming down. So why would we think that issues in this new set of spending would actually improve upon that track record that we had clients to payback. Well, you make it good, yeah, no, it's a good question. They're really good questions.

The first part with regard to Labor Force participation and the impact of the build back better agenda on participation, you're right. There are a lot of cross currents here. Some elements of the package would support a higher participation rate. some elements would weigh on participation. But I think the net of all those cross currents is to lift participation. And that is consistent with what's called it a meta study of all various academic

and other research that's been done on these kinds of policies and what they mean for participation rates. Some studies found big positive effects on participation, some saw net. negative consequences, but the net of that meta study which informed our work was that it would be a net positive. Let me say, for example, the point about higher taxes. Well, these are higher taxes on people with very, very high incomes, and I don't think, first of all, that's a small segment of the population of the labor force. Second of all, I don't think that will have a material impact on the labor.

on their willingness or ability to provide labor for the labor market, that they're motivated by many other different things, and the higher tax rate isn't going to encrypt their returns on that labor supply to the degree that is going to significantly weigh on participation rates. I mean, if, in fact, all of the tax increases proposed by President Biden were passed, the effective tax rate on high-income households affected by the package would only go back to its long-run historical norm, being back to World War II.

I mean, it's effectively all it's doing is rolling back the tax cuts that were implemented under President Trump, going back to where they were prior to that and where they were on average. So, I don't, you know, yes, all else being equal, that is a negative on participation, but I think it's very much on the margin and gets more than washed out by the, you know,

the benefits of the support to lower-income households females, workers, workers of color where participation rates are very low and it's very clear that they're not working because the commute costs are too high. They have to live in housing that's far away

from their work because of affordable housing shortages. That the cost of child care is too high. They don't get paid family leave so they can't stay in the workforce when something happens to them or their family. either the main caregiver. That is much higher, as a consequence to say, elasticity

than the tax rate impact on high income households. But there's a lot of moving parts there, and, you know, a lot to disentangle. But, you know, the net of all of that disentangling is that I think it would materially lift participation rates. the buildback better is, and it does lift employment, but only so far as it lists labor force participation

because, you know, if you're at a full economy that's at full employment, and again, I'm arguing that's where we're headed, the amount of jobs can only be equal to the number of, the increase in the number of jobs can only be equal to the increase in the labor force, otherwise you overheat. So, you know, I do expect more jobs because I expect higher labor force participation

than bigger labor force. But it's not, I think, the word you use, large increase in employment. You know, some near-term effects, you know, because you have access labor supply because of high unemployment and under-employment because a lot of people step out of the workforce. So you get some more, you get more bigger employment effects

early on, but in the long run of the next 10 years, the employment effects, I'd say, are, you know, they're modest, they're consistent, with the increase in the labor force. No more, and no less than that. But it continues for sure. Absolutely. Lots of complexity and lots of things proposed.

I think we're at the top of the hour here. Great. Yeah, I think we should. And what we'll do, like we do, all these webinars, we're going to answer all these questions. So, you know, if you have any additional, keep firing away. Heather, the producer of the webinar will bring them together, and I will respond to them in writing,

and we'll distribute that to everybody so that everyone on the webinar can see the Q&A. So if you have questions, you know, no need to stop posing them. Feel free to continue to post them. But I do want to thank Chris for graciously MCing this and to the audience for attending. And again, Inside Economics. I know, I'm hawking it.

You'll enjoy it, I promise. So come and visit Inside Economics. Thank you, everyone. Take care now.