Moody's Talks - Inside Economics - Humble Forecasting, Hopeful Outlook

Episode Date: December 9, 2022

Justin Wolfers, Professor of Public Policy and Economics at the University of Michigan, joins the podcast to discuss inflation, monetary policy, and prospects for recession next year. Are we being too pessimistic when so much is going well with the U.S. economy? Full episode transcriptFollow 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 Sandy, the chief economist of Moody's Analytics, and I'm joined by my two co-host, Chris DeRides, Chris. How are you? Doing well, Mark. How are you? Good, good. And we got Marissa, Marissa Dina Talley. Mercia's back. She was away for a couple weeks. Good to have you back. Thank you. Nice to be back. Yeah. And how was your week? Okay. It was good. Yeah. Good. You know, I was in Dallas this week. We were had a client, we've been having these client dinners across the country. And I think that was our seventh dinner since we started traveling this summer. And this was in Dallas. And you know what I've, and in these dinners, one thing we've been doing is having a poll at the end of the dinner where we ask the clients. And these are these are kind of small groups, you know, 10, 12 people, that kind of thing.

You know, what they think the probability of recession is in 2023. And of course, we have a long, lengthy discussion about what all that means, but we won't go into it. Anyway, you know what I've figured out? I have figured out that people's probabilities of recession are very dependent on the economic conditions in the place they live. That makes sense. Yeah. So, okay, here's the cities. New York, D.C., Toronto, I'm going east to West, Chicago, Dallas, San Francisco, and Honolulu.

Don't ask. It was a good one, though. So of all those cities, which city do you think had the lowest probability of recession in 2023? Lowest. Lowest. They were most optimistic. Dallas. Dallas.

Dallas. And it was 50% probability on the nose. Wow. Although I tipped them over the edge to 49 after they got my vote. Yeah, yeah. They lacked my insight. Yeah. You were supposed to be.

I was supposed to be there. You were supposed to be there. And I had to do all myself. And, you know, that's what happened. Yeah. You got the, you biased the pool there. I biased it a little bit. Guess which city, and this is a real test.

And you get a cowbell, if you get this right. Which city had the highest probability recession? Chicago. No. San Francisco. San Francisco. I was there. So that's, I have an unfair.

Oh, they were. They were there. Yes. They were. They were like 70, 80%. It was, we were going right in, man. We're doomed. And of course, you know, San Francisco is getting crushed by all the tech layoffs.

And Dallas is booming. Dallas is just off the charts booming. Everyone's moving into Texas. And they're all coming from California in San Francisco. You know, all the tech layoffs and house prices are falling more. I think Chris, aren't house prices falling more in San Francisco than anywhere else? Yeah. I believe according to our metric.

Yeah, but I found that fascinating. But the optimist, Dallas, 50%, so that kind of gives you a sense of the state of the collective psyche here. People are pretty nervous. And with that, I'd like to introduce our guest, Justin Wolfers. Justin, how are you? Good to have you on the podcast. Mate, it sounds like you eat dinner for a living. That seems like a, not a bad thing to do.

Talk us through Honolulu, would you? Studying the economy there? No, the problem is I don't get to eat dinner. I go to the dinner and actually all I do is drink, you know? This is the problem of being the most entertaining, most interesting person at dinner. All you got time for is a couple of swecks. Yeah, I get to drink the wine and because I can't, I can't eat while, you know, I'm like, you know, I'm seeing the group. But, you know, Justin, I don't know if you recall this.

Oh, of course, I should formally introduce you, of course. You know, everyone knows you. You're a professor now at Michigan at the Gerald Ford School of Public Policy, and you're also at the Peterson Institute, right? Do I have that right? You're a senior fellow there. You're a senior fellow at lots of different places, I think. Lots of things can be true at the same time.

No one pays me to eat dinner, but my main day job at the moment is at the University of Michigan in both the Econ Department and the Public Policy School. Yeah, fantastic. And then one thing I did notice, because I looked up your Wikipedia pages, as you would expect I would. You were born in Papua New Guinea? That's interesting. There is actually a chance that you are currently speaking to Papua New Guinea's greatest economist. Is that of all time? And I say that because I'm not quite sure I know the second best. Yeah. Now, how old were you when you left Papa? Well, I can tell you how old I was when I was born. Yeah. That's right. I left Papua New Guinea at the

age of six months. But Papua New Guinea at the time was actually called Papua and New Guinea. Oh, I see. That country was actually a territory of Australia. Oh, I see. And it was granted independence in 1975. I was born there just prior to that. I see. Now, I didn't look up the capital of Papua New Guinea. Port Moresby. But I think it begins with the letter B. Am I right? No, no, no, no, no, Port Moresby. I just gave it to you. Oh, yeah. Oh, yeah, it did. I was born at Port Moresby General Hospital.

Fort Moresby. Oh, really? That's so cool. Have you been back since? I never have. No. Yeah. Interesting.

That is fantastic. Oh, and I was going to say, do you recall, you spoke at the conference. Of yours. Yeah. And I think it was when it was still my, you know, was still economy.com. It was before we, I think were we? I remember that. I remember that.

I remember it in Pennsylvania. Yeah. Right. And I remember dinner. Do you remember what you talked about? If I now understand what economists do at dinner, they just drink wine. In which case, I likely have no memory. Probably about the economy would be my guess. Yeah, and actually, that was a great dinner, actually. Okay, because you got to eat this time.

I remember the restaurant. Yeah, I remember the restaurant. At the General Warren Inn. Yeah, General Warren in. That's a classic. You know, I think we had the Beef Wellington. Okay. As I recall, Justin, you spoke about the GDI, gross domestic income. That's all I ever like to talk about. And the good news is, Chris, like, you know, 10 years later, and you're trying to interpret what's been happening in the post-COVID economy, and you must be thinking to yourself,

these GDP numbers just don't look right. They don't co-hear with what I'm seeing around me. I should be looking at GDI, and you would stop, you would, if you'd done that, you wouldn't have used the R word once in 2022, and you would have been more accurate than almost anyone. So I love those three letters. For your listeners, GDI is gross domestic income, which sounds like it's different to GDP, but it's not. It's just another way of measuring GDP.

We add up how much income people get rather than how much money people spend, but because every dollar I spend is a dollar of income to someone else, they're really the same thing. Yeah, and so GDP declining in the first half the year, small decline. GDI, I think, increased a little bit in the first half the year, didn't it? For the, or maybe it was down a little bit in second quarter. It was generally more optimistic. More optimistic, yeah. Yeah. So you came to the conclusion, I guess, like I think most rational comestead that there was no recession in 2022.

The GDP probably wasn't the thing you should be focused on. I am quite confident there was no recession in 2022. Yeah, very good. Well, it's great to have you. Oh, and I should mention you, of course, have your own podcast, think like an economy. And you do that with Betsy Stevenson. And Betsy was so kind to come on the podcast earlier this year. If you try and create a fight between us, Mark, it's...

No, I wouldn't do that. Okay. No, no. I'll just say that her episode was highly rated. Yes, it was. The far as high. I'm well aware you went to her first, but I would too in the situation. She's such a great economy.

You're both, you know, fantastic. And I'm so glad you're here. I do want to kind of dive right in. There's three top of mind macro issues, all related. First, inflation, where's it headed? Second, what does this mean for monetary policy? What's the Fed going to do in response to all this? And three, where does this land us in terms of the economy in the next 12, 18 months?

And there's a bit of a parlor game now about recession. And you can see we were playing that game at these dinners. So let's begin with inflation. And before we go to how you're thinking about the future in inflation, can you weigh in, if you feel comfortable, on this debate around the causes of the high inflation that we're suffering right now? It's been distilled down to demand versus supply, obviously both demand and supply. But how are you thinking about why we're in this kind of high inflation environment that we're in?

This demand versus supply argument really matters a lot because it shapes how persistent you think the inflation will be and for the Fed it shapes how critically important it is or is not for them to be responsive. So the standard view is if it's demand, which is to say if the economy is too tight, too many people chasing too many things, then we've got to call the economy down and that's essential. The counter view is it's supply. By supply here we'd mean some kind of.

combination of Ukraine, of supply chain disruptions, and also the whole world just being a little bit upside down because of COVID and its recovery. The thing about supply shocks is one of the pages from the central bankers manual is that you should look through a supply shock. The simple version of this is Putin invades Ukraine, oil prices rise. Oil is an input into a lot of other stuff, a lot of other prices rise. Putin stays in Ukraine maybe. As long as he's not invading another country, what happens is oil prices stabilize.

They're high. People are pissed off. They should be pissed off. But if a price is high, that doesn't cause inflation. Inflation is a rise in prices. And so if you're just willing to be patient, the inflationary impulse from the supply shock disappears, in which case the Fed could cause a recession to get rid of inflation. It's going to just fall out of the system anyway.

So that would be the dovish argument right now is it was all a supply shock. The hawkish argument is, are you kidding me, 3.5% unemployment, the US has never successfully sustained this and therefore we need to slow the economy. There are two really interesting talking points for each. I don't want to, you know, I don't want to give you a super hot take. I prefer to educate. And so I think there are two things worth it about. One, the big talking point for the supply side folks.

Does that mean you're not going to tell us where you land in that debate? Is that what that meant? You and I have different jobs. I'm a professor of economics. I teach. I write textbooks. I want to give your listeners the ability to evaluate the arguments for themselves. You want them to have to pay you for dinner in order to get the insights.

So maybe we're competing. I don't know if you and I substitutes or compliments, Mark. All right. Chris and Mercer, listen very carefully to what he's saying, and we're going to interpret that and see where we think he's landing on this very important question. I think the, look, the big talking point for the supply side people is we're seeing similar inflationary pressures in just about every industrialized country, perenn, except Japan. And unless you thought that, you know, there was a Biden stimulus in every one of these countries, that's a very difficult pill to swallow. The difficulty for the folks who want to argue that the other difficulty for folks who want to argue that it's the demand side is the usual story is unemployment's low. Employers can't find workers, and they're all telling us that. therefore wages rise, therefore prices rise.

Now, actually, that intermediate step, therefore wages rise quickly is not really a big part of the story. And it certainly hasn't been through 2022. So through 2022 wages arising, you know, we can choose our favorite number somewhere between 4% and 5% while inflation has been up at 7 or 8. That doesn't sound like a tight labor market is driving wages and therefore business costs up. So that says there's something else going on. So, yeah, I think you actually probably don't need to listen too hard to hear me saying, I don't think it's all demand. And the real test of that theory is going to be the next six months.

Because the real one-offs are falling out of the system, right? So the energy price shock is a really big one that's disappearing. We're seeing rents coming right down right now. not seeing wages take off so far, a little bit of, you're a little bit more worried this week than we were last month. So if things keep up moving along at sort of seven or eight percent inflation over the next 12 months, then mark my words, I will definitely revise my view. But every time I talk to smart market economists, including folks on this podcast, they show

I mean numbers that suggest that inflation's coming down to three point something by the end of 2024, two point something if you're an optimist and four point something if you're a crazy pessimist. And so what that means is that within a year or two, inflation in the public imagination will be a much less pressing issue. And I think it's actually a really important framing for all of us thinking forward, which is right now you go to the grocery store and everything's expensive and you go to the gas station. It's not as bad as it was, but we've been complaining about that for a while.

And inflation has been politically salient. It's salient in people's lives. It's been worse than it normally would be because the prices that are most salient have been the ones rising the quickest, groceries and gas, right? When it's things like healthcare expenses, people never notice. And once it comes down to three point something, that's going to feel a lot like the kind of point something that it used to be right maybe only two points different and then we've moved from a the whole world is on fire to the Fed is uncomfortable and so I think the next year and

a half there's this very clear shift from you know seven to eight to two or three or four point something and then what happens after that it will really disappear from the public consciousness a lot yeah let me that that's all kind of course very consistent kind of the way I think about it as well. One thing, one thing I wanted to test out on you is that, that's kind of an added dimension to this supply side generated inflation that makes it different. It was a little bit of syncratic. It was that it was two supply shocks. The first one was the pandemic that messed up supply chains to this day. I mean, new vehicle prices are still going north because Japan and Germany can't get their production.

up to typical speeds because of supply chain issues coming out of Ukraine for Germany and China for Japan and labor supply disruptions, which still continue to this day. I mean, people are long COVID and child care issues. You know, they're still playing immigration, you know, still playing a role. And then that you had that underlying kind of inflationary force in place. And then you get nailed by the Russian invasion. Oil prices spike, which is kind of the single most important price in people's minds when they're thinking about, you know, where their financial health and also where inflation is headed. And these two things kind of conflated earlier this year. And that's when inflation expectations really took off. If you look at the surveys, bomb market expectations

around inflation, but probably more importantly in terms of wage demands consumer expectations. You know, You look at the University of Michigan survey on the consumer expectation inflation expectations or the New York Fed survey, same thing. So it was, it's supply, it's still supply mostly. Admittedly, if the economy was flat on its back and unemployment was at 6% that this wouldn't have happened, but economy was a full employment are pretty darn close. And then these two things came, these two supply shocks came together and conflated with each other in the minds of people.

And that's really when this thing metastasized. And that's when, of course, the Federal Reserve and other central banks went on Def Kahn one. Does that, does that resonate? That kind of argument? I think that's right. And what's important coming out of that is, you know, the language of this argument a year and a half ago was team transitory. And in some sense, the Putin shock will be about as transitory as our model suggests it'll be. The COVID shock's not that transitory just because this was the largest economic disruption of our lifetimes. And the idea that you can just shut down the economy and reopen it the next day and there's not going to be some kinks to work out of the system.

We have the largest sectoral shift between, you know, first to services and then back to goods. The fact that you, you know, the claim that things could just turn around on the dime is obviously silly. So the basic premise of Team Transitry was its supply shocks and supply shocks dissipate. And the political mistake they made is transitory in Washington means two weeks. in economics probably meant one year and in reality this time transitory was twice as long as that. And so, you know, we'll see over the next year. If inflation's not down to three point something in a year, a year and a half, I think then

it's time to say this whole thing, you know, team transit was wrong and team supply shock was wrong and it was all about demand and it's all about the Phillips curve. But I, you know, the other thing that goes against it's all the Phillips curve is, you know, the all the evidence for the past 30 years is that the Phillips curve is flat. Now to say that in English for your listeners, what we had was 30 years of sometimes having high unemployment, sometimes having low unemployment, no matter what was happening and inflation just didn't change. So it seemed like there was an incredibly weak link between unemployment and inflation, and now

all of a sudden we find unemployment a percentage point lower than make some people comfortable or maybe even two percentage points lower. all of a sudden the claim is that can explain inflation rising from, you know, two to eight, that would be wholly inconsistent with the last 30, 40 years of American economic history. Yeah. Let me bring Chris and Marissa into the conversation. And you heard what Justin's perspective on this, do you guys, would you push back on any of that, Chris, particularly you, would you push back on anything you just said? Because if you listen to it, let me, I'll interpret it first and then let you interpret it first and then let you interpret.

it's a pretty sanguine view if you believe that the supply shocks are going to abate and they are right i mean feels like it i mean the pandemic just you saw what china did with there's no covid policy that feels like that is going to allow supply in the end it's not going to be a straight line but it's going to normalize and then putin to justice's point unless he invades another country feels like you know oil prices are going to stay roughly where they are and so the inflation generated by the surge and energy prices during the year will come out of the system so that feels pretty sanguously went to me. And if that's the case, then, well, we'll get to monetary policy and what it means for the economic outlook, but you could connect the dots. So how do you, would you push back on

anything he said? I think it's all quite reasonable in terms of the interpretation of the demand and supply and how we are working through the various issues. One complicating issue, I'll submit, see how you react is just on top of all this, we are undergoing significant structural changes. I would argue when it comes to de-gabilization and trade the remote work, so changes spurred on by the pandemic. So those could be more structural. They could be longer lasting. And given certain assumptions,

you could assert that there would be a higher level of underlying inflation in the future. Or I guess you could make a counterargument. Well, the demographic trends haven't really shifted all that out. scrambled them a bit during the pandemic, but we are an aging population, perhaps that would argue for a lower, a still low level of inflation, underlying inflation in the long run. So does that enter your calculus at all? Are these non-secretors or? No, no, this is a really, really smart point. But I want to rephrase it in statistical

rather than economic terms because I think it'll lead to a slightly different argument. We had a pretty standard US economy from about 1982. to 2019. And it seemed like one simple model could fit it. And I used to teach my students an ISMP-Philips curve sort of a model or a three-equation new Keynesian model, which for your listeners, is just jargon for the underlying equations that Chris, Marissa, and Mark have in their computers. And everything was pretty simple.

Now, pandemic economics is different, fundamentally different. And so we all suspended those models through 2020 and 2021 because the laws of supply and demand in very important senses have been suspended or at least worked differently. And in 2022, inside these models, there are lots of deep constants, things that we think of as not changing, right? And Chris, your observation is all shit, everything changed. If that's the case, yes, we're going to revert back to using those models because we think it's a normal-ish economy, but we're uncertain about everything.

And I'll give you one example, but it's really just one of, you know, I think you and I could think of a dozen examples like this. When I say everything's changed, it's how the economy works, but also how our data collection works and what the data means. So here's a simple one. Wage growth has been surprisingly weak given the very low unemployment rate and the rate of inflation and the claims that workers have bargaining power. Here's a possibility.

Workers have a lot of bargaining power and what they're doing is instead of asking the boss for an 8% pay rise, they're saying how about Mondays and Fridays at home? That would be one where they're taking their pay rise, they're just taking it in another form. It would show up in our data as weak wage growth. If you look at how much people value work from home, the answer is a lot. If you look at how many people are negotiating over it, the answer is a lot. So could this drive a large wedge economy wide between what's really happening and what we're measuring in our wage statistics?

And I think the answer turns out to be yes. So when you said, if you were to say to me, Justin, what's the underlying rate of wage growth? I could look up the data and it sort of says five, five and a half. But I could say, well, there's a story actually. It's kind of like eight and a half or nine, you know, like because the rules of the game changed. Now we can tell stories like that actually about almost any economic statistic. Right. Let's take, I read in New York Times column during the pandemic, which said, you know the thing about work from home, not work from home, about the lockdowns. The lockdowns were counted as a loss of economic activity. Now, the lockdowns were a way of preventing people from getting COVID. We have a different technology for preventing people from getting COVID now. It's called a vaccine. If we were able to buy a vaccine in the year 2020, how much would you have been willing to pay for it? The answer for many of us is literally thousands of dollars.

So what that means is when each of us was staying at home, it's not that we weren't doing work in the office. It's that we were producing a flow of services to our fellow citizens, keeping them safe, that is exactly equal and has the same consequence of giving them a $5,000 vaccine. And so 2021 or 2020 looks in the books like a terrible year for GDP, but that's a statement more about how we measure GDP rather than what we were doing. We're doing incredible work looking after each other. Let me try and bring this back to what you're working on. Then we can talk about inflation, right? What does inflation mean when half the goods aren't available at the local store? How do you measure inflation when it used to be $30 to go to a really nice restaurant

and get table service and now they give you semi-cold food in a foam container and tell you to drive it home yourself? So, you know, what does it mean to think about the flow of housing services, when you're rarely home as we were before and now we're always home. So now I'm getting another eight hours a day of housing services and I paid not a penny for it. What if rent was on a per hour used basis? So all of this is just a way of saying, I don't really trust either our models or our data. Now to bring it back to the actual work of the day, what should all economists be saying about the next two years?

The answer is we should be unbelievably humble. Whatever you think your confidence in it will is, first of all, the behavioral economists will tell you it's always 50% too narrow. And then now we say because of COVID, it's probably, you probably want to double it again. And so, you know, maybe the right way of thinking about things is much more balance of risks. And, you know, as we transition to the Fed discussion, one way of saying this is the Fed doesn't get to choose where the economy is going. It gets to choose which mistake it's going to make. and, you know, in a world in which we truly don't know what's going on, it really is about choosing which mistakes we're going to make

rather than thinking we're going to thread any needles. Well, that's, that's your, the measurement discussion is fascinating. And I hadn't even thought about much of what you just said, but it, you know, really, I think strikes a lot of points home. But getting down to brass tax, I'm at the Fed. I got to set interest rates. Right. And I got a target, and it's called 2% on the, I got the core consumer expenditure

deflator X food and energy. This is the thing I'm pegged on. Yeah, there's a boatload of uncertainty and who knows what exactly I'm measuring. But on the other hand, I still got to set the interest rate, which affects everybody's lives through house prices and stock prices and crypto values, that kind of thing. So back to Chris's question, do you? think the way we, based on the way we actually measure inflation, it feels like before the pandemic, after the financial crisis up to the pandemic, we had all these kind of secular

headwinds to inflation, you know, de-leveraging and globalization and, you know, the labor market really up until the end of that cycle wasn't very tight. You know, we had very pedestrian wage growth. And that was, those were kind of headwinds in the Fed and other central banks are fighting like the dickens to try to get rates relatively low and get inflation back to target. Now the argument out there in the world, if you listen to investors and policymakers,

the argument is that these headwinds to inflation now have become tail wins. But they're new tailwinds. Globalization is over, and if we're not de-globalizing, we're slow-balizing. We're not going to get the benefit from that. We've got the transition clause

from going from fossil fuel to renewable, so that's going to be a cost. And in terms of labor market, we got all these demographic trends, aging out of the boomer generation, less foreign immigration means perennial tight labor market and workers have the power now to demand higher wages and therefore higher inflation.

Therefore, the Fed's not going to be, the reserves and other central banks are not going to be fighting to get inflation up. They're going to be fighting to get inflation back down. Does that kind of resonant? with you those arguments or or not i'm just going to commend you on the courage of your argument that a time of seven percent inflation with a two percent target your forecast is that the fed is going to be fighting to get inflation down um i i'm not sure there's a deep argument about that beyond the near

term you know when you look out five years from now ten years from now that kind of thing um i'm a simple fellow so i'm going to give you a simpler perspective okay um if i had spent every year since 95 simply predicting that inflation will be 2% next year. Yeah. I would have been close nearly every time. For sure. When you got a rule that works, probably keep using it. Okay.

Got it. Got it. And so, you know, it is really hard for complicated models to do better than dumb predictions like that. Like, you know, what's been happening in the past is what's likely to continue in the future. So my guess is we're looking at roughly two for until some point at which the Fed changes its mind about what its target is. Okay, let me ask you one other question about that. And then let's move on. This is kind of the segue into what it means for monetary policy in the

Fed. There's this chatter, and I just kind of out on the periphery, feels like it's coming more into the mainstream kind of debate and argument. Maybe the Fed shouldn't be targeting that 2%. You know, maybe they should be targeting something higher than that. The logic being, you know, at 2%, assuming the economy's real potential growth is 1 and 1 half to 2, your nominal potential growth, you know, what the economy can grow without generating inflationary pressures is 3.5 to 4, you get into a recession every single time. You're going to, the Fed's going to be forced to push interest rates to the zero, lower bound to zero, and then have to engage in something they don't feel comfortable, particularly comfortable

with quantitative easing, buying mortgage securities and treasury securities. So why not set the target, not at 2, but something? thing two and a half. I'm making it up three. And don't talk about it now because you talk about it now, that would be pretty counterproductive inflation expectations would rise and make it much more difficult to get inflation in. But as you're, you know, on the other side of this, this time next year going into 2024, that's a pretty opportune time to say, oh, hey guys, we're not going to two. We're going to two and a half or three. Does that, does that resonate to you that argument whatsoever? Does it matter, you know, from your perspective? So first a little

history. So during the global financial crisis, 2008, 2009, it became very quickly, very clear the Fed couldn't do enough to dig the economy out of a hole. That's when very serious, very prominent people like Olivier Blanchard, for instance, suggests we raise the inflation target to three or four percent. And it turns out, by the way, if you look at the latest research from my side of the tracks, academic macroeconomists, there's probably some evidence. that 2% is too low of an inflation target. And part of that is because we keep hitting the zero lower bound. We're hearing whispers of it right now.

I will tell you in the circles in which I run, the whispers I hear are coming mostly from the left wing of the Democratic Party rather than, you know, Blanchard is a center left technocrat. And that was where it was coming from, sort of, you know, the sort of center of the economics profession was willing to come back and have a look at it. I'm not hearing mainstream economists say now's the time to do it.

That doesn't mean they're wrong. The argument that was made back in 2009, 2010 has a lot of validity. And it's likely that we are going to spend a lot more time with the zero lower bound. We just went ahead and did it again. The question then is how to do it. There was this notion back in the late 80s and 90s. You probably remember it. That was back when inflation was too high and we used to talk about opportunistic disinflation.

Yeah, that was green span. Yeah. Remember that it'd be like something just knocks inflation down and then you just lock it in. That was the idea. And you sort of hope it comes for free. And so I think if your argument as being a symmetric flip side of that, opportunistic inflation, you know, in all of this, I think maintaining the public confidence is going to be the real trick. And the current environment, highly partisan environment, which we find ourselves, is one where I would be not at all confident if I were J-Powell that I could lead the

to public in a sensible conversation about whether to, there's no point moving from two to two to two and a half. That's spending a lot of political capital for half a point. So you either decide you want to hit four or you leave the argument alone. And could I have a coherent, sensible discussion with the American people and bring them along? Or are the gold bugs and the crypto nuts and the political opportunists going to make it sound like you're hyperinflating your way out of, say, a big public debt? and that really does undermine what the Fed's doing right now. And I suspect that political constraint is a really important one.

Yeah. Okay. Hey, Mercer, let me bring you into the conversation. Anything here so far that strikes you, something you want to reinforce or something you want to push back on? Yeah, I think, you know, my interest is the labor market. So I think this, I think it'll be fascinating to see what the impact of the hybrid work the remote work means for just frictional unemployment, right?

In theory, this should make labor markets run much more smoothly and job matching to be much easier. If it doesn't matter where I'm located and I can find a job anywhere in the country or anywhere in the world, this should reduce some of that frictional unemployment. And people like to come down definitively on one side of the, remote work is great for productivity or, you know, this is really changing the game. But we don't have any data definitively yet to really say, A, how big of a impact this is having on the overall labor market, productivity, wage growth. And we don't know how ubiquitous it is.

And we also don't know how permanent it is. I mean, you hear stories all the time of people that left and they left San Francisco and they moved to Salt Lake City, but now they're coming back, right? And some employers are asking people to come back into offices. So I think it's going to be years before we truly understand what this all means for the labor market. And I think Justin's comments about wages and that perhaps it's not showing up in monetary compensation, but employees have more bargaining power and non-wage benefits, and one of them being remote work or hybrid work is a really interesting point. Because, yes, theoretically, we should be seeing much stronger wage growth than we see right

now given a 3.7% unemployment rate. You know, we have falling real wages, and we have for over a year since the pandemic started. That's varied a lot by industry, and you do see cooling across some of these industries where They were really impacted by a lack of supply of labor like restaurants and bars and entertainment and that sort of thing. That's come down from double digits last summer to something that's kind of right above that 5% wage target. So I just think the jury is still really out on what all of this means for the labor market. So I think drawing conclusions about structural shifts due to the pandemic in the labor market is way too soon. And drawing conclusions about the failure of structural shifts to occur is also too soon.

Right. Yeah. And this also has, you know, the other part of inflation, the way the government measures the consumer price index, 40% of it is housing. Right. So all of this shifting labor market, people moving, it's all still shaking out how this is going to impact house prices across the country. Are we going to get to some sort of regional convergence, which, regional economists have been talking about for 40, 50 years and has never really truly happened. We keep saying it's going to happen and all the models have this happening, right? That eventually every region of the country will converge to some sort of similar wage rate, housing rate as people move around. So this should accelerate that in theory,

but we're not really seeing that now. We always have these very expensive coastal cities that have these extraordinarily high runups and house prices. And then they have, you know, we were just talking about San Francisco, right? That's an old story with San Francisco. This is nothing new. So it's just, I'm not convinced that we've seen this major structural change in the labor market and migration and mobility that is here to stay that we have to account for. But I don't know. Maybe it is, but we're not going to know for probably several years to see how it,

how permanent or, or temporary it is. Just you know, Marissa came from the BLS. So she's in, she's into the weeds on how to measure things. So down to the DNA. You know, I just one counted, Melissa, Marissa, and maybe just context rather than counter. I'm 49 and three quarters years old. In fact, by the time this podcast airs,

I may be 50. Congratulations. Thank you, sir. It depends how long the podcast goes. You look fantastic. How do you do? Like there's no gray hair, you got plenty of hair. You lead a good life.

I'm sure you're drinking plenty over there in Ann Arbor. I'm drinking a hot cup of tea right now, Mark. The Elixir of Youth. But at age 49 and three quarters, I'm totally confident that this is the largest disruption to economic life in our lifetimes. by a substantial order of magnitude. It may be thinking about the Great Depression is the wrong analogy. It may be thinking about a war mobilization and demobilization is a better analogy,

but this is a generational marked shift. And while I think you're absolutely right, Marissa to say, I'm waiting for evidence before I call things permanent or call a structural shift, this is the one time in my entire life I'd be on the lookout for a bunch of structural shifts. Because if they're going to happen, they're happening now. If not, they're never happening. Sure. I agree with that.

I think the debate is around the magnitude, right? I don't think we're disagreeing that there's a structural shift, but how large is it? Early returns may suggest it much larger than what we find later on as things do adjust. Right. And so a reasonable way of, you know, I think sometimes what economists need to do is just figure out how many zeros are on the end of something. And that's why I actually think war demobilization might be a way. figuring that out. And that's not going to give you a precise number. It's just like how many

zeros are involved, right? And what did that do? That gave us Rosie the Riveter. It gave us the entry of women into the workforce. It gave us new family forms. It gave us new urban geographies. So we have seen major population demographic shifts coming out of major moments. Yeah. I think. Sorry, Mercer. Just I want to move the conversation on a little bit because we're going to run out of time. There's a couple things I want to do with Justin before we run out of time. First is play the game, the statistics game, if you don't mind. And then we're going to go come back and end the conversation. And I'm going to push you a little bit on the outlook, you know, where I know you don't do forecasting for a living, but, you know, just to get your

sense of where I just don't do it for free. If you want to write me a big check, I'll do it. Everything's got a price. The outlook here, because we have this, you know, we're, really focused on the economy and how it's going to be performing in the next 12 months. But the game, the game, just to remind everybody, we each put forward a statistic. The best,

and the rest of us try to figure that out, questioning and clues. The best statistic is one that's not so easy. We get it immediately, not so hard that we never get it. And is apropos to the discussion or something recent. But that's a, Justin,

those are just rules of thumb. Yeah. Feel free. And let's, If you don't mind, I'm going to begin with Chris. Chris, you want to go first? Sure. 56.5.

I think I know the answer to that. That's going to be some kind of ISM number. Very good. And given the state of the economy, that'll be goods or is it services? Services. Non-man manufacturing. Yeah, yeah, yeah. Non-man.

Yeah, because the ISM manufacturing actually turned negative. It went below 50. That's right. Yeah, yeah, yeah. I just got the two confused. No, no worries. So, Chris, I'm disappointed, my friend. But, you know, that was too easy, 56.5. No? Well, I got a wrong number. Yeah. Okay. Let me ask you. Mercer, did you know the answer to that question? Yeah. So, okay. So, so, but. Oh, she didn't shout it out, though. Come on. Yeah, we were being polite. So, but anyway, why did you pick that, that particular number? It's a strong number. 56.5 is up from 54.4. So indicates that the non-manufacturing, the service sector of the economy continues to expand here, even as manufacturers you mentioned, continues to retreat. This is the 30th

consecutive month of expansion of the non-manufacturing sector. So back to Justin's earlier point, in terms of going from services to goods, back to services. We're clearly moving in that direction. and I also chose it because I think this does complicate the Fed's outlook as well. I knew it was coming as we get into the into the monetary policy discussion. Is this good news, bad news situation here? Or does this really show the strength and the resilience of the economy and therefore we just have to be patient as Justin indicated in terms of inflation? But you view this is good news is bad news.

This meaning the economy is strong, resilient, therefore inflation is not going to come in easily. Therefore, Fed has to raise interest rates, therefore we're going into recession. Yeah, that's my take. I get all the therefore is right. I think you're doing. I am so confused by someone saying the economy is doing well, so therefore we're going into recession. Right? That sort of says a forecast to rise and you're suggesting faster growth today is slower growth in the future.

That, I would like to see an econometric specification that shows that. Because generally when things are going well, they keep going well, and when they're going bad, they keep going bad. Sometimes they don't, Justin. We do have recessions. Until it doesn't. But the recession continues, to Marissa's point, things are bad, and it keeps being bad until it's, till it flits.

But we generally think there's positive persistence in the state of the economy. But you can't, you mean, look, the economy is strong. job growth is strong, labor markets are tight. So the concern is that it's not going to cool off sufficiently. We're not going to get wage growth down something consistent with the Fed's inflation target. And so when you get statistics like 56.5, strong growth, nothing slow. And the concern that we overheat increases, that kind of logic, right? I mean, you're saying that's not a reasonable logic?

I'd say check out some of the intermediate steps in that long chain of logic you just used. So one of them was that, you know, wages start to kick out of control rather than just saying, well, because we saw an ISM number like this, I know that that's what's going to happen. Why don't we just look at the wage number? Oh, yeah. I mean, this is kind of being sort of, again, a little forward looking forward looking forward. You know, good news is bad news has always confused me. Yeah. And this is just one sector, right? Yeah. If manufacturing is going down, maybe that could be a precursor of, you know, services just hasn't caught up yet. So this is a me, 80% of the economy. Let me put it this way, Justin. Okay. So the economy, if you believe the numbers, and we can debate the numbers here too,

underlying job growth month to month is $250K. That feels like that's greater than underlying the growth in labor supply. Therefore, it feels like the tight labor market, 3.7% unemployment rate, 80% EOP for prime age workers, is going to continue to tighten. and if it continues to tighten, that means wage growth won't moderate, and therefore we, the Fed will continue, this is the Fed's model. The Fed's going to continue to raise interest rates, and at some point, it's going to break, therefore recession, right?

So we've got to get this job growth down, and you get a 56.5 on the service side of the economy, then maybe you're not going to get that moderation. Does that not resonate? I just want to go back to the argument I made that we should be humble right now. Okay. Right. So unemployment three and a half seems low. But employment to population is still well below the pre-pendemic trends, literally millions of workers below. So I think the argument is the economy is either really close to full employment or it's not. And I just want to make sure

we say the or it's not part. The one thing we're confident of is it's not miles over, miles past it. And so, you know, how many people two years ago would have said unemployment is going to be 3.5% by the middle of 2022. It felt unimaginable during the deepest moments of the deepest recession since the Great Depression. So the deep constants that we think we understand and we think we know

if you try and estimate how true are they a lot less than we like to suggest. Yeah. Yeah. Okay. I'm in this weird position, Chris, you can tell. Yeah. I'm pushing back on Justin and he's like right in my camp, so I have a feeling

he might be even beyond you. It might be a bit beyond me. Yeah. Okay. Mercy, you're up. What's your statistic? Okay.

My statistic is 4.6%. 4.6%. 4.6%. Statistics that came out this week? Yes. Now, this week makes it hard because nothing interesting came out this week. It came out today. University of Michigan.

One year had inflation. He's got it. That's my Justin Wolfer's tribute. Oh, wow. I just got burned. Bad one. I thought you'd get that. You got Britain, baby.

I am going to say, Marissa, the truth is I follow the University of Michigan football team more closely than I fail. I've seen that on Twitter. Yes. Yeah. Yeah. So this is one year ahead inflation expectations from UMISC consumer sentiment. That was down from last month where it was 4.9%. So these are consumers' expectations of what inflation will be in December of 2023.

And it's the lowest it's been. in 15 months since September of 2021. So inflation expectations are coming in even by this survey, which is highly sensitive to gas prices at the pump, right? And those have come down recently. So perhaps some good news for the Fed that consumers are starting to buy into this notion that they're going to be able to bring inflation down. Now, I will say that two things I want to point out about this.

consumers are really bad at predicting inflation. So if you look back at these surveys of households and economists, to be frank, they're worse than they're worse than economists. Yeah, I think so. I'll try to verify that empirically. I have a paper on it if you want to verify. Oh, you do. Okay.

Oh, good. Okay, there you go. So I'm right, right? Like, if you look back at these, what they say inflation is going to be one year from now or five years from now and what actually is panned out, they're, they're, they're, are pretty bad. I mean, the psychology of thinking what it, what it is right now is what it's going to be, right, a year from now. And then the other thing that we've talked about is this disconnect between the University of Michigan consumer sentiment and the conference board, which is

more focused on the job market and wages, which has been way more optimistic than the assessments coming out of Michigan. And the gap between the two has never been. bigger. So there is never in the history of the two surveys been such a disconnect between people's assessment of current conditions. Can I ask before the pandemic, what was inflation expectations when you're out? Because it's really, they're making, if you're assuming, everyone's making the same errors on. Yeah, I mean, it was right around two and a half percent. Was it two and a half? Yeah, it was like right in the sense. Yeah. Yeah. Okay. So it's, they're still very, very elevated to be sure, but they have been steadily coming down. And with the Michigan,

it really does follow whatever gas prices are doing. Right, right. Interesting. Okay, very good. That was a good one. Justin, you want to go next? Sure, but I'm going to change the form of the question. This statistic is at or near its highest level in the pre-pandemic 2000s. Now, I'm sure there's a lot. Oh, hold you. Say that again? The statistic, it's the growth rate in something. Okay. It's at or near its highest rate in the pre-pandemic 2000s. Nothing ever beats the pre-during pandemic growth rate, right?

Because they were crazy. Oh, I see. Some real economy statistic is growing as fast as it's ever grown in the 2000s, excluding the pandemic. Okay. So something in the GDP accounts? I didn't say that. I said real. But that's part of the game.

We get to ask questions. Oh, right. I didn't know that. You didn't have to tell us that. You don't have to tell us. No, not a NIPA statistic. It's not an NIPA. It's in the labor market statistic?

It is a labor market statistic. It's one that people focus on a lot. Oh, and it's the strongest growth rate excluding the pandemic period, pre-pandemic going into the 2000. Okay. And it's positive growth. So something that's growing very strongly. Is it something, is it an industry growth rate? It's an aggregate.

It's something that gets a lot of attention. It's something we all care a lot about. Oh, really? It might be the most closely watched economic statistic. It can't be payroll. It's not payroll employment growth. It is. Oh, it is?

If payroll employment growth is running, you know, you have to see that some month to month. But you said payroll employment, It's growing at about 250. Numbers like 250, 270. Okay. We literally never achieved it through the 2000s. It's not a great one for a guessing game, but it's rhetorically important in the sense that if you talk about the state of the labor market, one, there's levels, the unemployment rates at a 50 year low. Two, there's changes.

The current rate of change. I mean, this was the baffling thing through 2022. People are calling me up every day? Are we in a recession? I'm like, I don't know. why won't you call him in 2001, 2002, 2003, 2004, 2005, 2006, and every other year when we weren't getting payroll's growth this fast. It's a mind-blowingly fast rate of payroll's growth right now. And people have just totally lost connection with how incredibly fast payrolls

are growing. Yeah, that's a good. That's a wonderful point. Yeah. Remember when you see, you'd get 200,000 jobs a month and it was like, wow, that's amazing. Freak out. Yeah. Well, here's the other mind numbing thing that people just haven't gloved on to yet, but forecasters know for sure. If you look out three, five, seven, ten years from now on the other side of this adjustment to the pandemic, job growth is going to really slow.

We're going to see 50K, maybe, 25K a month. And people don't understand that. it's not resonating with them yet. But it's going to be a very different world, you know, dead ahead on the other side of the pandemic adjustment. Yeah, but that's a good one. That was a really good one. We're running out of time, so I'm not going to do mine because I want to move on before we lose you.

And thank you again for participating today. Would you mind playing, it's not a game, but this forecasting. Sure. I guess it's a bit of a parlor game, right? Recession, no recession. So because it kind of capsulates immediately where people's minds are with regard how the economy is form next year. So the question is, and I'm going to ask the other guys and then you, Justin, what is the,

what do you think the probability of us entering into a NBER defined recession? So broad-based, lots of industries, persistent, not a few months, but the average length of recession since World War II's 10 months, something like that. beginning sometime between now and let's say the end of 2023 just to make it, you know, rhetorically easy. And let me go to Marissa first, then Chris, then I'd go to you. And then if you're interested, I'll give you mine as well. Go ahead, Marissa. And tell us where you've been, where you are now, and if it's changed, why. Okay. And it's really not a parlor game. It's really become a drinking game for you, Mark. Oh, is that? Okay. Okay.

What kind of drink? Can I ask? I'm just really curious. I mean, you're a wine guy. This is real inside of your personality. We just talked about you asking this question over bottles of wine. I've heard he's even given up food in order to just get to the wine. There you go. It's the first sign, isn't it? Yeah, it's the first sign. It sure is.

Yeah. So I'm becoming increasingly more optimistic that we're going to avoid. There it is. There it is. Very good. We're having, okay. So what's your probability? So I would say I'm at 58%. Oh.

Okay. She went from 60 to 58. That's that's, that's, precision too. That's humble. Oh, she's round.

Dicimal points involved? Perhaps. I'm rounding. That's a former BLS economist right there, huh? Well, I was at 66 a few months ago. That's true. That's true.

Tell me why are you going, Tell me why you're growing more optimistic? The data is because you're having more cocktails or you're drinking more glasses of wine. Yeah, that does tend to make me more optimistic. But it's not that. It's, yeah, I think it's that I'm just increasingly convinced that we might pull off getting inflation under control without causing a recession. My odds are high because I just feel like if there's any. other shock, supply shock, energy price shock, something geopolitically that, you know, rattles things,

that we may not be able to withstand that. But there's, there's no reason. The distribution of shocks being symmetric. And so maybe we'd get good news about something. That is, that is true. And I never think about the good news, I have to say, because it's. Yeah. Yeah.

Okay, that's good. I think that we're, you know, I'm, I'm more optimistic because you're more optimistic. You see how it works? Yeah, it kind of feeds on itself. It does. Okay, here we go, Justin. We're going to the dark side. Here we go.

Go ahead, Chris, lay it on us. Please, wow. Just, you know, taking it interesting here. I'm sticking with 70%. Okay. I was contemplating an increase. But Justin got to talk me down back to, back to, I've been at 70 for months here. I remain convinced that there will be a policy misstep, largely because of those data issues

that we have been discussing throughout, that there will be some misreading here, and we'll end up hiking much more aggressively in a short period of time that, as a consequence, although payrolls have been great, they will start to falter here, and we'll go into recession, probably later in the in 2023. And can I ask, you said you were thinking about raising the odds, were you being, you were just jesting, or are you really more pessimistic than you were four, six, eight weeks ago about the economy's prospects in 23?

Mostly in jest, but there are certainly a few things here. Okay. A few data points. Inversion of the yield curve continues to bother me. And in fact, I want to get Justin on the next podcast or one. soon just to talk about the yield curve justin because this thing is driving me crazy you know but it's incredible how the yield curve was able to predict the pandemic that's what makes it such a reliable indicator that's a good line indeed indeed that is a good line i mean people who told me that it predicts

all recessions are telling me that fact well you don't know the counterfactual you could there would have been a recession anyway you know we were going in anyway you know one way or the other so anyway so jason what's your probability if you don't mind yeah i'm going to frame it first. So I saw a Wall Street Journal article which surveyed a bunch of comments about a month ago and they said the average probability was 65%. And some were as high as 90 and that struck me as insane. So what's funny of course is then I come on a podcast and the two numbers that come out of 66 and 70. Is it re so a different way of doing this is to say well we really know nothing about the world in the last hundred

years there's been 14 NBER recessions. So if I knew nothing, it's a 14% chance. So then I'm going to bound it and I'm going to say it's between 14 and 65. How do I feel about 65? I went back and I looked at the survey of professional forecasters. And I looked at, you can see how what percent chance people think there is that there'll be a recession, that there'll be negative growth next quarter. And it turns out that does peak from time to time, which is to say that forecasters really do predict negative growth sometimes, usually in the second or third quarter of a recession, which is to say in the entire history of forecasting, we've never actually forecast a recession with any success whatsoever, in which case anyone who thinks

it's above 65%, I think, must think that either this, either this is the easiest moment to forecast in the history of the US economy, or they're overstating their confidence. I don't think it's the easy moment. I think they're over stadium. So therefore, I think it's between 14 and 65, and I'm closer to the 14 and than the 65 in. I'm not saying 14. Because also, then I ask people, why are you worried about a recession? And Chris, they always give your answer, which is the Fed could screw it up. It is true. The Fed can make mistakes. This is where I want to play the same trick on you. I played on Marissa. It could make two mistakes. It could tighten too much and it could tight and too little. I know folks in the Fed, they seem pretty smart to me. I don't think I know

which side they're going to screw it up on. And so, just as Marissa is right to say, I'm worried about external shocks. Look, I'll tell you, I'm not that worried about the Fed shock. I am worried about the rest of the world, because the rest of the world looks pretty rotten. But, you know, all the unknowns have a symmetric distribution, which includes good news. And so I think this 65% is, like, wildly overdetermined. And then the other thing is, what's the other thing is, what's the best preventative for a recession. It's approaching with momentum. And we're approaching the end of 2022 with a ton of momentum. So it'll require a really negative shock to knock that momentum down to zero. And so let me end with, I know if I've been run along here, Mark.

I just want to make some of the social. I mean, if you have time, that's fine. I want to run a sociological insight by you. It is simply that economists are trained to look for the worst and everything. As a And journalists only want to tell stories about things we can go wrong. That means all the happy stories don't go told, don't go told. And all the happy thoughts go unthought. And so if I were to give advice to your listeners, it would be, I'm talking to professional grumps and ask themselves what isn't being said because of the pervasive grumpiness bias, and then use that to inform their assessment of recessions.

Look, I could well be wrong. I was once told the single best thing to do is predict a 40% chance or something. Because then when the recession doesn't happen, I can say I was right. And if it does happen, I'm like, I said it was a 40% chance. Pretty high. That's the weather forecaster. Yeah. So let me predict 40%.

But the truth is, that's my public number in my heart. I actually think it's a little lower. A little lower. Okay. Okay. Very interesting. Yeah. Well, I'm going to go out on a limb.

I'd say 50-50. To be humble. but I will to be humble but if I have to pick aside because I do I think we make our way through without it's going to be under any scenario a tough year

I think it's going to be a difficult year but I think we make our way through without recession and I I actually feel increasingly more optimistic because it goes back to inflation and everything is pointing to inflation moderating here and I like what you said

Justin you know I I can state with a pretty high level of confidence, assuming, you know, oil prices don't go skyward again, that inflation is going to be three, three and a half percent by the end of 2023. And at that point, you're at spitting distance, you know, whatever target is. And I think the Fed reduces the odds. The Fed makes the mistake of pushing us into recession at that point. So, and then even, even that, I think we have a, we have a fighting chance to get back close to the Fed's target, which on CPI, somewhere in the mid two's probably by sp summer of 2024, something like that. I mean, yeah, things can go wrong, but to your point, there's two-sided risk. It doesn't feel like it's one-sided to me. So, but, but the final thing I'll say is, and does echo what you said? I think the moment of truth is here. We're going to figure this out here pretty soon, one way or the other.

But I want to thank you. This was a fantastic conversation. I know you're feeling a little bit under the weather, but so thanks for hanging out with us for an hour. much appreciated. And, you know, I need you on this podcast often to counter the dark side, the dark pessimism, you know, I'm dealing with over here. Just keeping it real.

Real dark, Chris. With that, we'll call it a podcast, everyone. Take care now.