Odd Lots - Goldman's Jan Hatzius on the Lessons Learned in 2020

Episode Date: December 28, 2020

2020 has been an absolutely extraordinary year for the economy. In March, we saw the fastest economic contraction in history with an extraordinary surge in unemployment. Now, as the year closes out, we've had a housing boom, an extraordinary rise in financial assets, and unemployment has fallen much faster than most people expected. We spoke about this with Jan Hatzius, the chief economist at Goldman Sachs. We talked about the lessons learned, inflation, the outlook for 2021, his sectoral balances framework for analyzing the economy, and MMT.See omnystudio.com/listener for privacy information.

Thanks for listening to Oddlots. Follow the show on Amazon Music for more future episodes or just ask Alexa, play the podcast, Oddlots on Amazon music. Hello and welcome to another episode of the Oddlots podcast. I'm Joe Wisenthal. And I'm Tracy Allo. So I don't know about you, Tracy, but I would definitely say that when the crisis hit earlier this year and the stock market crashed and layoff surged, I definitely. definitely got pretty intense flashbacks to the Great Recession, the financial crisis 10 years ago. Yeah, I mean, I think a lot of people did. I think the big debate that was going on at the time was whether or not 2008 or 2020 was going to be like the defining financial crisis for a particular group of people. And I think that debate's still going on, but for sure, like we've never seen any. anything quite like this. And in March, we had a financial crisis alongside a real economy crisis with lots of businesses going into lockdown and things like that. And I think that was probably

the major difference with what we saw in 2008. Right. And I think now in December 2020 and looking at the aftermath, we can say safely that so far anyway, the aftermath of what we experienced in March and April has really been nothing like the financial crisis. Of course, we have stocks, not just at all-time highs, but well above the pre-crisis highs already. Home prices. There's a housing boom happening, which probably not a lot of people would have guessed. You know, the unemployment rate, it's still quite elevated, but it's come down a lot

faster than a lot of people anticipated so that another sort of difference from 2008, 2009, where the recovery and unemployment was extremely slow. Yeah, I think that's right. And certainly if you talk to a lot of people in March, no one would have expected to see the rebound in risk assets that we've seen. And no one would have expected that everyone would be buying, you know, houses or those people that can afford them would be buying houses. I do think the big difference this time around has probably been how quickly the Federal Reserve

of reacted and also how quickly Washington rolled out that stimulus package, which kind of begs the question about what comes next, because as we're recording this, the next round of stimulus is stuck in political gridlock. Right. We are recording this Wednesday, December 16th. There are some headlines this morning that they might be close to a deal. So by the time people are listening, we'll probably know. Also, there is a FOMC decision today.

So again, we're having this conversation prior to that. You know, in the context of the sort of surprising recovery and how it's not like the GFC aftermath, I think one of the first clues or one of the first people who helped me really understand the difference was our guest today. We're going to be speaking with Jan Hatsius. He is the chief economist at Goldman Sachs. role he's occupied since 2011. And it was a note of his, I think, sometime in April, making what at the time was, I thought, a pretty extraordinary call, which is that he thought, thanks to the CARES Act and fiscal stimulus, that household income would actually be up in 2020, which is not what you

expect to see when the unemployment rate is spiking. And to me, that was like one of the first times I saw someone like really crystallized this idea that this is going to be a different year, that the 2008, 2009 playbook cannot really apply to this kind of a crisis. Yeah, I agree. And a lot of people follow Hatsius's work. And I do think some of what he's written about recently kind of gets to the heart of the big question going into 2021, which is how is the consumer going to react? What's consumer confidence going to look like, are we going to get this pent up demand scenario where once we get a vaccine and the lockdown gets rolled back, everyone goes out and spends and makes up for a lost time by going to bars and restaurants and things like that? Or are we going to see some sort of permanent

damage to consumer confidence after the events of 2020? Absolutely. Well, I can't think of a better guest to talk about to finish up this extraordinary year. the economy and look ahead to next year, then Jan Hotsia. So, Jan, thank you very much for joining us. Thank you for having me. You guys are being too kind. So tell us about the crash, the crisis from your perspective. A, did you also get some of those 2008, 2009 flashbacks? And how quickly did you realize that that playbook would not apply to 2020? Well, we saw. certainly got some flashbacks in March, given the lack of normal functioning in a number of financial markets, especially the bond markets.

I mean, there were a lot of comparisons, and there were a lot of people that thought, actually, if anything, this looks worse than 2008. Now, that may have been in the heat of the moment while you're going through it, of course, it always looks worse. But there were definitely some very, very unsettled weeks when there was a lot of concern about market functioning. I don't think there was ever the same kind of concern about the financial system. So I think that was a difference even going through. I think there was a generally greater degree of confidence that financial institutions were in much better shape, partly because of the regulatory response.

that we saw after the 2008 crisis. But in terms of market functioning, I think there were clearly some flashbacks. I think it was also clear, taking a somewhat broader view and not just looking at what happened in the bond markets, that the economic backdrop was quite different. The downturn, it became clear very quickly in early March was probably going to be significantly bigger

than what you had in 2008. just in terms of the decline in GDP in the second quarter. And the drop was driven by very different factors. It wasn't driven by financial factors, ability to pay or asset values, but it was really driven by a physical constraint on economic activity. So, I mean, there were some similarities, but I also think that it became pretty clear that the economic environment was, you know, it was just a very, very different shock. And I had to be really analyzed, I think, in its own right and not really through the lens, not too much through the lens of 2008. So Joe mentioned your April note where you sort of identified some of the differences between the 2020 crisis versus the 2008 crisis.

More recently, I believe you have a pretty out of consensus call on economic growth for 2021 versus the rest of the street. What are you seeing that other people aren't seeing at the moment and also back in April? I think it goes back to the previous question. I do think that it's a very different cycle. So that's really the main answer. I think it's a very different cycle. It was really driven by a health emergency that forced us to shut down parts of the economy. And it wasn't driven by a bursting asset bubble and a credit crisis that,

that might have taken and did take years to unwind after the 2008 crisis, and to a degree, to a much mild degree, even after the 2001 recession and after the 1991 recession, those were all driven by really financial factors and financial imbalances that took a long time to unwind. This was driven by a, you know, just very different. factors. You know, I think policy plays a very important role as well, as we discussed. The policy response by both monetary and fiscal policy was so much more aggressive this time. And my favorite statistic in terms of how that sort of looks in the economic data is the fact that the second quarter of 2020 saw the biggest decline ever in GDP and the biggest increase ever in real disposable income.

And mostly these things are correlated when one is down, the other is down as well, and vice versa. In this case, they not only went in opposite directions, but in both cases to a record degree. And I think that really speaks to the enormously aggressive policy response that we saw in the U.S. and in a number of other countries as well. So as mentioned in the intro when we're recording this, we don't actually know what's going to happen with whether there will be an additional round of fiscal stimulus or not. But, you know, one thing that we do know is that at least on the aggregate basis right now, household balance sheets, they look very healthy. People have a lot of cash. They have a lot of savings. And so forth. So look ahead, you know, let's say like we're having this conversation again in December 2021. And presumably by then we've had a successful

rollout of the vaccine and the economy is fully reopened, knock on wood. How significant is the prospect of fiscal stimulus or how different does the economy look in December 2021, whether we get this extra jolt of fiscal stimulus in the meantime to get us through from now until reopening? I think from that perspective, it's not clear how big the difference is going to be between a situation where we get near-term stimulus and a situation where we don't. I do think that in the shorter term, as far as, you know, the remainder of 2020 and first quarter and maybe second quarter of 2021 is concerned, it's going to make a significant difference. There is still a strong case, I think, for providing additional support of the economy, because in the short term, despite the fact that the vaccine is likely to help a lot and bring the economy back to normal to a large extent in 2021, in the short term, virus cases continue to be

extremely high, and the economy is still far away from full employment, despite the progress that we've made. So I think there is temporary weakness that I think is very amenable to policy support. And there's a strong case, especially if it's, you know, a temporary amount of weakness, there's a strong case for using both monetary and especially fiscal policy to to relieve the hardship that is being caused by this near-term downturn. Of course, monitoring fiscal policy aren't the right tools to address the health emergency itself, but they can greatly reduce the fallout in terms of jobs and incomes and knock-on effects to other sectors of the economy.

So on that note, I have a related question, but how much, I mean, we've seen financial conditions loosen quite significantly in the aftermath of everything that's happened in March. How much do easier financial conditions offset the damage to the real economy? Well, easier financial conditions certainly help in supporting aggregate demand. I mean, the point of our financial conditions index, which is currently at its easiest level on record, and we have this back to the early 1990s, the point of, the point of the financial conditions index is to measure how the channels of monetary transmission, you know, bond yields, equity prices, credit spreads, currency, how they are affecting the real economy.

And if you're at a very easy level and you've seen a sizable easing in terms of rates of change, then you're getting a positive impulse to the economy from that. And so that's certainly helping. but at the same time, we are well below employment, and inflation is well below the Fed's target. So, you know, more support to the economy is still helpful. And I would say also that on the fiscal side, of course, if you provide income support to those people in the economy are most hard hit by the weakness. I mean, they generally don't benefit from easy financial conditions. They might get an indirect benefit, but directly, if financial conditions are easy, that doesn't

replace income directly. So that's still a job for fiscal policy. Were you surprised, speaking of not replacing income directly? I mean, we're having this debate now about stimulus, but we've had a long gap and the expanded unemployment insurance that was established under the CARES Act in late March. that ran out, I think, at the end of July. And so we've had this long gap of sort of a bit of a removal of fiscal support. Have you been, were you surprised in sort of late summer, the fall, that there was not a more pronounced

ramification from the end of that extra expanded aid to the unemployed? Yeah, we were a little surprised by that. We would have thought that we'd get a clearer signal. or clearer signs of deterioration. When we look at some of the microdata on spending by unemployed and employed people, we do find some very clear effects of the expiration of the $600 checks, and then we see a sort of temporary increase in spending by the unemployed again on the back of the executive orders that partially replaced this six-step.

hundred dollars, but only for a temporary period. So that shows up pretty clearly in the data, but the levels are generally higher than you might have, than you might have expected the levels of spending by the unemployed. So I think it probably shows you that the initial amount of income support, both from the unemployment benefits and from the tax rebates, was large enough to provide a bit of a cushion and boost the level of spending for a period of time. So it's probably still being boosted to some degree by the earlier stimulus. But that's obviously not going to last forever. And there are some signs, including in the November retail sales report released this morning,

that boost may be running out at this point. So this is something that I'm really curious about, but how much did stimulus sort of muddy the outlook, the future outlook for consumers and consumer confidence? And also, how are you thinking about the consumer going into 2021? Because as I mentioned, there is this debate at the moment. Are the unusual events of this year going to encourage people to, you know, permanently cut back on spend? and raise their savings because they're more uncertain and they're worried that an unexpected event like a global pandemic could come out of nowhere and they might lose their jobs and things like that. Or are we going to see this big rebound in consumer spending, the pent-up demand theory as the vaccine gets rolled out and lockdown gets rolled back? I think you've laid out well the two sort of extremes in that discussion. I'm more on the on the side of the second rather than the first.

I don't think that there's going to be a permanent impact. I think people are going to go, my expectation would be people are going to go back to spending money on similar types of service activities and service experiences that they were spending money on before, obviously always subject to their own economic situation and a bunch of other factors, but I don't think that there's going to be a large amount of behavioral scarring if you get into an environment where the risk of getting infected is much lower or the consequences of being infected are much lower. And I think there could be some degree of pent-up demand for services.

I think that's more uncertain whether you are going to see, say, demand for travel and and entertainment actually move above the previous base, the pre-pendemic baseline for a while, I think it's harder to know. It wouldn't be, you know, behaviorally, it wouldn't be too surprising that if you haven't been able to do any of these things, you might do, you know, you might go to an extra concert or do an extra trip. But for me, the main thing would be that these are still sectors of the economy that are operating far below normal.

And I think when we have a vaccine and when the vaccine has led to effectively herd immunity, you know, whenever that is sometime in 2021, I think we'll see a return to normal levels for these parts of the economy. And that is going to give you a boost to the level of GDP by, you know, maybe 2% or so if you take it in aggregate. Obviously, much bigger increases in those specific sectors. On April 4th, 2023, around 2 in the morning, a man was found stabbed multiple times on a sidewalk in downtown San Francisco. Hey, who did this to you?

What happened next turned the story into a political firestorm. Reports have identified the victim as Bob Lee, the founder of Cash App. From Bloomberg Podcasts, this is Foundering, the Killing of Bob Lee, beginning April 16. So I want to shift the conversation a little bit because besides the sort of immediate what we're seeing in the economy, you know, Tracy and I always like to talk about economic ideas and how those evolve. You have been a long time. I don't know, you just sort of take, you look at the economy through what's known as a sectoral balances framework, which is associated with the economist, Wyn Godley, who's been an influence on your work. I'm curious if you can sort of give us our listeners like a brief description of what this is and how that helps you look at the economy. And then like how that's helped you understand the economy in 2020 and looking ahead what the framework talks about. Because I do think it's sort of a, it's a different way of thinking about the economy than certainly I would say most Wall Street economists. Yeah, it's basically a focus on especially the private sector financial balance, which is just the difference between the total income and total spending of all households and businesses.

And you could disaggregate households and businesses, but I often find it more useful to look at them together because in some cases, it's difficult to distinguish between where the household sector ends and where the business sector begins, if you think, for example, of small businesses and entrepreneurs. So if you aggregate up the entire private sector and private sector runs a financial deficit that happens often on the back of large asset price increases or asset price bubbles, for example, in the late 1990s stock market bubble or the 2000s housing market bubble, that means that the private sector is quite vulnerable to bad development in asset markets or other shocks because they're already spending beyond their current level of income and are having to finance the difference with net debt accumulation.

And that can continue as long as asset markets are performing well. But if asset markets start to turn down households and farms need to cut their spending relative to their income, that generates a negative impulse to aggregate demand and often results in a recession. And we saw this pretty clearly in the U.S. in not only the 2008 crisis, but also in the 2001 recession. And frankly, we've seen it time and time again in other advanced economies in the last two or three decades in Europe in the run up to the 2008 crisis. Spain is an extreme example. We've seen similar things in the UK in the early 1990s and a bunch of other economies. So this is something that I'm quite focused on as a warning sign of financial imbalances and vulnerable.

vulnerability of the real economy. And basically households and firms living beyond their means, or at least beyond the shorter means, is a danger sign. And one of the things in 2020, and especially in the spring lockdowns in the second quarter, that was very, very different from those past episodes, was that the private sector was actually running a huge financial surplus and much bigger surplus than you'd ever seen before in post-war history. And while that's not the only thing that matters for the economic outlook, it was certainly one thing that gave us confidence in calling for a pretty rapid recovery

from the sort of margin April lows. So I do think it had a big impact on our thinking in 2020. And of course, it was very related to the policy decisions that we just talked about, the decision to provide substantial amounts of transfers to the household sector that showed up in the private sector financial as well. Right. So, I mean, on a related note, since we're talking about financial imbalances, on the one hand, the policy response did help enormously in stabilizing markets and in providing a cushion for consumers as we've been discussing. But now with stocks sort of at all-time highs and with, you know, the corporate bond market booming and lots of other weird things happening in capital markets like SPACs and big IPO booms and things like that,

do you see an issue of financial instability looming or do you worry about, moral hazard at all? I don't see, I would say, imminent signs of financial imbalances that are relevant for, that need to be addressed, let's say, by monetary policy. I don't see that. I mean, of course, you should never say never. It's always something that I think central banks and policymakers have to monitor. But again, if I go back to the private sector of financial, financial balance as, you know, one metric of financial imbalances, the private sector is still running a very large surplus, past kind of asset price busts that have had really negative effects on the real economy have typically been preceded by large private sector deficits,

where, you know, households and firms were effectively spending too much relative to the income flow on the back of very rapid debt accumulation. And so these increases in asset prices had much more tangible effects on, you know, people's borrowing and spending behavior. I'm not seeing that. You know, that doesn't mean, of course, that there couldn't be any imbalances. And there certainly doesn't mean that there couldn't be price declines in different markets. But I do think that it tells you probably that the vulnerability of the real economy

to these kinds of adjustments is probably lower than it would have been in many of these other episodes. That would be my starting point. And it's, I think, similar in spirit, at least, to the reviews that the Federal Reserve undertakes kind of regularly, where they look at valuations and valuations of different types of assets. That's one important input. And then they also look at economic behavior and spending and borrowing behavior and leverage in the economy and in the financial system.

And both of those are important for whether they think the risks are elevated. Right now, you could probably make an argument in a number of areas that valuations are becoming more ambitious. So maybe you ratchet up your level of concern somewhat there. But if you look at the behavior, the borrowing, leverage in the system, and you're talking about the private sector here, I don't think there are really any signs of that would make you really worried. So Tracy always used to make fun of me, but she hasn't lately, and now I feel kind of bad, but she always used to make fun of me for always asking a modern monetary theory question on our interviews. But I'm not going to do that yet, but I might get to that in a second. But I am kind of got a hint at that, which is what's interesting to me listening to you describe this framework is that the vulnerabilities are really on the private sector balance sheets.

And so you look back at 1999 and 2000, everybody thought, oh, there's this amazing boom. The economy is great. The federal government is even running a surplus. But your framework identified warning signs because the private sector was actually running into deficit. at the time, and then we did indeed have a crash not long thereafter. Do you see more and more people appreciating this? I mean, we still, in the media, people always like to talk about the size of the national debt and the deficit, but do you see a greater appreciation of this sort of inversion of that where the concern is really on the private sector's debt and deficit as opposed to the public

sector one. I do. Yeah, I think there has been, there has been a shift in emphasis and certainly the experience of the, you know, both the 2008 crisis and the aftermath of that. And this, this year, I think, has contributed to that. It's been, it's become, I think, pretty clear that large government deficits, especially if they occur in response to temporary, you know, temporary downturns, large but temporary downturns in aggregate demand, that those are typically not nearly as dangerous as I think many people would have said before the 2008 crisis. And I think this year has made that even clearer because the policy response was that much more aggressive.

You know, I think on the private sector side, I think you will find a reason number of people who've been concerned about private sector imbalances for a long time and asset price imbalances for a long time. And, yeah, we're trying to persuade people that the private sector financial balance is a useful metric of that. You know, I would say there hasn't been a breakthrough on that particular metric, but we'll certainly continue to talk about it because I think it's a nice summary of, you know, imbalances that people might otherwise look at in a more kind of piecemeal fashion. But I think that debate continues.

So I'm going to leave the MMT question to Joe, because I know he does want to ask them. But I want to ask a different sort of big picture economics question, which is you wrote quite a lot about the productivity puzzle or the productivity mystery over the past 10 years or so. this is the idea that productivity growth has been really surprisingly sluggish, and there are lots of different theories about why that might be. I'm curious whether the experience of 2020 and the experience of having different parts of the economy effectively shut off has informed your opinion on what's driving that productivity puzzle at all. Have you learned anything about productivity this year? We have a lot of questions about productivity.

I'm not sure that we have full answers yet in, you know, in terms of what we've seen in 2020. What's certainly striking is that productivity has done really well in 2020. So if you just look at the numbers, you know, we've seen very strong productivity growth through the year. Now, part of that is because the sectors of the economy that are still very disrupted are generally low productivity sectors like restaurants and personal services that where productivity value added for work or our work tends to be lower. So there's a composition effect in these data. But it seems like even if you adjust for that composition effect or you look at the numbers on an industry by industry basis, you've still seen a pretty significant increase in productivity. And the question, I think, is that temporary or permanent, it might hint at a better period for measured productivity growth than what we've had in the kind of pre-2020. you know, 10 or 15 years.

So that's a very intriguing question, you know, whether perhaps in this, in this terrible pandemic, we actually have found some ways of increasing productivity that, you know, will prove to be a permanent benefit. You know, for example, if you think about the changes in retail from brick and mortar of stores to online retail, that certainly be something that boosts productivity over the longer term. Obviously, there are disruptions associated with that, but it is something that I am very interested in. The 2020 prices doesn't really tell you anything about the key thing that I was focused on for the last several years, which was how much of the weakness and measured

productivity growth reflects measurement error as opposed to a true slowdown. I do think that there is a very good case to be made that we have gotten worse at measuring productivity growth. There's a big debate about this, but it does seem to me that the economy is becoming harder and harder to measure as we move away from producing homogeneous goods that are easily counted in terms of tons of steel and bushels of wheat towards, you know, services and virtual goods that are very difficult to measure and where it's very difficult to estimate prices and where it's therefore hard to follow the sort of national income accounting paybook

of counting up receipts and then applying a price index in order to get a real output measure and then dividing that by all its work, get a productivity measure. There are a number of areas or steps in that calculation where you end up having great difficulty measuring. So I don't think 2020 has really shed any additional light on that, but I still think it's an important issue. Speaking of productivity, I mean, I know one theory I've heard people put forward is that low productivity is in part of function of,

low overall demand, under employment, companies not feeling a big urge to invest when overall demand is strong, companies not feeling a big urge to invest in new technology when labor is plentiful. How much in your view could just sort of pure demand side aspects of the economy play in productivity? And then beyond that, you know, one of the lessons learned, I think, from 2020 is that simply giving checks to unemployed people or lower income people as an incredibly powerful form of stimulus. So I'm curious, like, what your view is on just sort of pure demand side policies overall as both the key to the productivity puzzle, but also just going forward in terms of a focus of how that can sort of make the economy more robust and get us out of downturns quicker.

Yeah, I mean, I totally agree. on the second part of that question, that if you're in a slump, finding direct ways of boosting aggregate demand is a very sensible kind of policy endeavor. And I think we took a very direct, and policymakers took a very direct approach in 2020, and it has worked very well. Obviously, was still going through it, but I would say the early returns are quite positive. Now, this was a particularly obvious policy in this downturn because he had this huge shock to economic activity, but at the same time, it was pretty clear that it was temporary. Obviously, back in March and April, you didn't know how quickly we would have a vaccine and it now looks even more clearly temporary

than it did back then. But even back then, it was very clear that it was temporary. So in that sort of environment, the case for stabilization policies, you know, aggressive demand side stabilization policies is very, very strong. And I think, you know, it is a good lesson to take away, even though not every downturn that we'll have in the future is going to be quite as clear cut as this one. On the impact on productivity, I'm less sure. I mean, I think there are certainly some cyclical effects on productivity through labor utilization and labor hoarding or shakeout of employment.

So I do think you always want to try to adjust your productivity measures for utilization. And there are some estimates that do that. The San Francisco Fed provides some of that adjustment, for example. Typically, once you average over a somewhat longer period, though, which you always have to do with productivity numbers, you never really want to look at quarterly. I think once you do that, typically you find that the cyclical effects are not enormous, and they can go in both directions. It's not always the case that a stronger economy also means higher productivity or faster productivity growth. In fact, often you find that late in a business cycle when you're already very close to full employment, firms basically have to resort to hiring the lowest productivity workers, which is good in terms of

employment outcomes, but may not be so great for measure of productivity goal. So I think the case for demand-side policies to stabilize the economy in the slump is strong but doesn't primarily rest on the brookivity score. So you mentioned the vaccine briefly then, and of course the successful rollout of the vaccine factors into your V-shaped economic forecast for 2021. But I'm curious how that actually impacts your outlook for inflation. And we haven't touched on that specifically. But if we were to see economic growth come roaring back and if we were to see an uptick in

spending, would you expect that to translate into price increases of one sort or another? Yeah, over time, I think you will see higher inflation in a stronger activity environment. So if you put more pressure on the labor market, you fill what's still quite a large gap in the labor utilization, I think you're going to see upward pressure on wages and, you know, ultimately also upward pressure on price inflation. I mean, these effects, you know, Phillips' curve effects, you can show them in the data, you see it for wages, you see it for prices, and statistically there, they're definitely there, they're just not very strong, and the size of the impact is not very large. And so,

you need quite a lot of strength in real activity and quite a lot of pressure on labor markets to get these kinds of increases in wage growth and price inflation. So by our estimates, and we have an optimistic view on growth. We're at 5.3% for US GDP in 2021. but even with that, we only get to 2% core PCE inflation on the sustained basis in 2024. And then that also shortly thereafter, we have the first hike in the funds rate. And so that's all working assumption. I'm June Grosso, inviting you to join me for the Bloomberg Law podcast.

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Law podcast with me, June Grosso. Subscribe today wherever you get your podcast. So obviously, I mean, over the last 40 years, we've just seen this incredible, you know, disinflation, even when we get an up cycle in-prudgment. prices, the pace of inflation tends to be lower than the previous peak. You don't see it picking up anytime soon. Do you have, in your mind, a cogent theory for why we've seen this multi-decade disinflation and what policy shifts or what any kind of shifts might actually reverse that on a sustained basis? I would disagree with you slightly on the downward trend, at least in the U.S. I mean, I think what we've had is basically a low inflation environment since the mid-1990s,

where you've had, you know, kind of one and a half to two percent for the most part, if you take the core PC index. And the peak inflation rate at the end of the 1990s cycle was, you know, about 2 percent, little, you know, a little of, and it was a bit higher than that at the end of the subsequent cycle. this time again, we only got to about 2%. But it's basically been in that sort of range. Now, why has it been so low relative to prior cycles? I think basically because the Volker and early Greenspan bed were very adamant that they wanted to bring down inflation from the 1970s in the early 1980s levels.

And they wanted to stabilize inflation expectations at a low level of, you know, maybe 2%, but they weren't particularly concerned if it ended up being somewhat lower than 2%. You know, there used to be the so-called comfort zone that beneficiaries talked about, which was 1 to 2% for the PCE index. So, effectively, I think they got what they wanted. And then over time, in recent years, I think the Fed and any macroeconomists have thought, well, what we wanted at the time is probably a little bit low because the neutral interest rate is, the real interest rate is significantly lower than it was before.

And if we only have average inflation of 1 to 2%, we may have too little room to cut rates and ease policy in response to a slump. So we want to make sure that we at least average 2% rather than average 1.5% to give ourselves a little bit more room. And I think that's the thinking behind the framework review that we got from the Fed this summer. you know, 2020 was full of surprises. And I don't think a lot of people had a global pandemic necessarily on their list of major risks to their economic outlooks going into the year. But I'm curious, for you, what was the biggest surprise of the year? Other than the pandemic itself? Yes. Like, in terms of, in terms of the economy, the way it reacted to the pandemic or in terms of lessons learned. Well, we saw a pandemic that initially maybe didn't look so different from some of the other scares about pandemics and other pandemics that we've seen in previous years, H1N1.

And I think the fact that we had seen a number of scares like this without really large economic effects, at least in the U.S., that added to the surprise of just. just how devastating this pandemic was in terms of the impact on the economy. Back in January, some of the early reports certainly looked scary, and I think they looked concerning to a lot of economists, but we also all remembered that we heard some of these warnings before, and in the end, at least the economic impact didn't turn out to be that large. So I do think that is a large surprise. I think the other thing that's been remarkable, we've talked a lot about the demand side of the economy, but I think on the supply side of the economy is how adaptable the many

structures in the economy really are. If you look at, for example, the shift from brick and mortar retail to online retail, you look at the level of US retail sales. that we very quickly got back to the pre-crisis level, even the mode of delivering the goods have changed dramatically. I think the fact that working from home, you know, for all its problems and all its disruption in terms of individual lives, ultimately, you know, worked quite well in terms of maintaining output and maintaining productivity in a lot of sectors.

I think that's been impressive. So, yeah, I mean, I think there are quite enough. of surprises, but the biggest one, I think, continues to be the pandemic itself. Just going back a second, I wanted to clarify one thing on inflation. Do you see the Fed's new framework, the average inflation targeting framework as being a meaningful change going forward? Is this regime change, or is it a slight technical tweak that ultimately won't matter much? And do you think, what are the sort of knock on effects if they adhere by this approach of essentially not snuffing out inflation

too soon and actually trying to get it to average around 2% rather than a 2% ceiling? It's a good question. I mean, I think you could say it's a very significant change because you apply the same framework to the prior cycle and you probably would have gotten quite a bit less interest rate increases than then you ended up getting. Probably wouldn't have gotten a hike in 2015 and only a much smaller number of hikes than, I guess, nine hikes that you had subsequently. So I do think that there was a, there's been a significant change from that perspective. On the other hand, I don't think that they're going to be willing to tolerate much higher inflation than they did in the previous regime.

I mean, I do think it's sort of a 50 basis point kind of shift. And you had 1.5% on average, or 1.6% on average in the 20 years before the regime shift, I think will be at 2% or so. I don't think the average is going to drift higher to 2.5%. or to three percent. So from that perspective, I don't think the implications are so on us. So I guess the short-run impact on any individual cycle, and especially any backcast of an individual cycle for monetary policy, those changes could look pretty significant, but in the long term, I don't think it's a massive routine. You know, you are a sort of adherent of the work of Wyn Godley, whose sectoral balances framework, which we talked about, is sort of one of the

pillars, I guess you could say, of the MMT view of the economy. And sometimes there are articles about MMT and you're often cited as a sympathist, one of the sympathists on Wall Street. So I'm curious, like, your take on this sort of framework and whether you think it sort of pushes us in the right direction in terms of understanding the economy and policy responses, like what your view on it is. Yeah, I try to be sort of eclectic in terms of what we find useful. And I do think that when you're in a slump, you know, often aggressive stimulus to, you know, in order to combat that slump, both from the monetary and the fiscal side and less worry

about government deficits in the short term, I think that's often the right policy response. And I think that is, you know, from that perspective, maybe related to the MMT prescriptions. I also think, though, that when you're, you know, when you're in a strong economy, you're back to full employment and the central bank's inflation target, that the policy prescriptions change pretty significantly. while I certainly agree that a government can't technically go bankrupt, if the central bank buys the debt, I think the right policy prescriptions in the full employment economy are going to look quite different from the MMT prescription. So in my view, it really depends on the situation you're in.

And then I would say on the private sector financial balance and the sector of balances approach, I do find that quite useful in a number of respects, but I wouldn't necessarily put any particular label on that, although I'm always very happy to give Win Godly credit for pushing the strength much and directing our attention to it in the past. All right. Well, Jan Hatsias, thank you so much for joining us. A real treat and pleasure to get so much of your time,

and I'm looking forward to reading further your work and see what 2021 has in store. Thank you so much, Joel. Thank you, Tracy. That was great, Jan. Thank you so much. Tracy, I always like talking to Jan. I was like reading Jan.

And like I said, it really was him more than anyone else who back in the spring, his identification of the power of sort of replacing lost income and how big of a deal that would be. that's sort of helped me see that's like, this is not exactly going to be like 2008, 2009. Yeah. And let me just add, I'm so glad that we can round out the year with talking about sectoral balances and the wind godly framework. Excellent to do that. That sounds facetious. No, I'm very happy for you, Joe, that you made that happen.

Just going back to Hatsias' his framework of the crisis, I do think he's absolutely right that this crisis is incredibly unusual. And we haven't really seen anything like it in, well, I guess all of sort of financial market history. But in many ways, it's this government-induced crisis because the lockdowns are being mandated by public health authorities. And in many ways, it's also a government-solved crisis, possibly precisely because of that. So we've seen the Fed come in and politicians in D.C. come in and offer either monetary easing or some sort of fiscal stimulus. And so far, it has had a fairly enormous effect. And that's had, I guess that's had the consequence of compressing the entire recession into a, much shorter cycle than it would be otherwise and certainly a much shorter cycle than what we saw

in 2008. It's very controversial. You said this was a government-induced crisis. I mean, I'm sure the lockdowns have had a significant effect, but also the sort of inclination to just avoid getting the virus is also pretty big. Yeah. I mean, I think you could debate that there. But I would, look, I'm in Hong Kong and I'm close to the mainland and I'm close to China. And so maybe that colors some of my perspective. But I would say, like, authorities kind of chose to shut down vast swathes of the economy, certainly in the U.S. And anyway, let's not get into that. Let's talk about the economy and MMT. You know, no, I do think like this sort of question of when are we particularly vulnerable is like a huge thing to think about now and also the future.

I mean, 1999, there was probably the peak optimism about just the economy and prosperity and everything seemed really good in a way that I don't think we've felt in since then. But that was when the private sector started running this deficit and people spending more than they earned in part due to the wealth effect, perhaps, of the dot-com bubble. also saw that again in 2005, 2006, I think 2007, at the peak of the housing crash. And then you look now and you see, okay, household balance sheets in aggregate were in good shape going into the crisis. In aggregate, they actually look better today than they did at the start of the year due to all the saving. And so, you know, there is a good reason to think that we do have this potential cushion of stability that could prove to be a real benefit in the coming years. Yeah, and also just the idea that household balance sheets look better now than they did at the

start of 2020. I don't think anyone would have expected that in March of this year. And it just goes to show you how unexpected certain economic developments have actually been. Yeah, absolutely. I mean, I don't think for all the sort of modeling you can do about, okay, If you spend this much money, then that replaces this lost income and so forth. I don't think anyone could really have predicted that this is where we'd be in mid-December 2020. No, and we should definitely have Yan back on at the end of next year and see how everything panned out. I think that would be an interesting conversation. But for now, shall we leave it there?

Yeah, I like that idea. that's an annual December, end of year Christmas conversation, Christmastime conversation with Jan Hotsias. Sounds good, but yeah, let's leave it there. Okay. This has been another episode of the All Thoughts podcast. I'm Tracy Allaway. You can follow me on Twitter at Tracy Allaway.

And I'm Jill Wisenthal. You can follow me on Twitter at the stalwart. Follow our producer, Laura Carlson. She is at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesca Levy, at Francesca Today. and check out all of our podcasts under the handle at podcasts. Thanks for listening. April 29th and 30th, Bloomberg House arrives in Miami at the Formula One Grand Prix.

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