Plain English with Derek Thompson - U.S. Economy FAQ: Skyrocketing Insurance Prices, Stuck Inflation, Higher Rates, and Wrong Experts

Episode Date: April 16, 2024

Jason Furman, a professor of economics at Harvard, returns to the show to discuss the biggest economic questions of the moment, including: - Why have home and auto insurance prices skyrocketed? - Why did inflation stop falling in 2024? - How did economic experts get their disinflation forecasts so wrong? - What sticky-high prices are preventing further disinflation? - Are interest rates going to be higher for years? If you have questions, observations, or ideas for future episodes, email us at [e-mail].  Host: Derek Thompson Guest: Jason Furman Producer: Devon Baroldi Learn more about your ad choices. Visit podcastchoices.com/adchoices

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New episodes starting March 28th. On Spotify or wherever you get your podcasts. Today's episode is about why the last mile of America's war against inflation isn't going as well as we hoped. And where the sting of sticker shock is sharpest. We'll start with the overall inflation. Last year, I thought America was headed for what some economists call a soft landing that is a continued decline in the inflation rate

without any meaningful increase in unemployment. And this wasn't just my prediction, I should add. It was the expectation of markets as well. The Federal Reserve itself indicated that it looked forward to cutting interest rates several times in 2024, which would be quite nice for anybody seeking a mortgage or dealing with credit card debt. But the first quarter of 2024 has been a bit frothier than I thought it would be in ways both good and bad. The economy is growing faster. than I thought. The labor market is adding more jobs than I anticipated. But also inflation's

decline, which is sometimes called disinflation, has paused. Last year's story was that core inflation, which is stripping out the most volatile prices like energy, core inflation was slowing down, and the Fed said it was ready to put the finishing touches on its big mission accomplished banner, pull down rates. But that's not the story of this year at all. Core inflation is stuck at a somewhat elevated level. And that means that prices for all sorts of things are still rising faster than most Americans are used to. Even if, I hasten to add, even if real wages overall are rising.

But the most interesting part of the story, the most curious, confusing part of the story, is what happens when you descend from the headline inflation numbers to a couple specific inflation categories. After all, the federal government tracks overall inflation for what it calls a basket of goods, but then also it tracks specific inflation for things as nitty-gritty as chicken, makeup, shirts. And one of the most interesting and alarming categories for inflation at this very moment is the high and rising cost of owning a new house or car.

Car insurance prices surged 22% in the last year. car repair prices surge 12%. It is now less affordable than any time in recent history to buy a home, the Wall Street Journal reported in December. And it's not just because of the obvious thing, which is that interest rates are high, so mortgage rates are high. Just about every price related to homeownership

has also been rising. Property taxes are up, utilities, maintenance costs, all rising faster than wages. And worst of all, home insurance premiums are on an absolute rocket ship, rate surged by more than 10% in 19 different states reviewed by the journal. So what is going on with insurance?

22% inflation for auto insurance, double digit inflation for home? The answer here, or at least what I'd gather to be the answer, is I think instructive. Like sometimes we think about inflation as a number on a dial that is controlled by a party that we don't like. So the left looks at inflation, gets mad, and says, well, we'll blame Biden. Or the left looks at inflation and gets mad and says, oh, we'll blame corporations,

corporate greed. And of course, both sides have an opportunity to be partly right. Biden's deficit spending, probably buffeted inflation. Many companies really do cover higher producer prices by raising consumer prices even higher. But most of the time, inflation is caused by a complex interplay of supply and demand and behavioral factors that nobody really controls. So to our question, why are insurance rates spiking especially for home and auto? Well, let's start with cars. Number one, car repairs are getting more expensive because Americans own nicer cars with heavier and more complex parts. Number two, there is now a shortage of mechanics, which means mechanics can demand higher wages, which means insurance companies have to cover higher labor costs.

And number three, American driving has just gotten worse. There are more accidents than there used to be. There are more distracted driving than there used to be. In many parts of this country, I've definitely seen this in D.C., law enforcement has pulled back on trafty safety enforcement almost entirely. You're probably happy to get fewer tickets for speeding. I certainly am. But in the aggregate, fewer speeding tickets means more accidents.

And more accidents means higher insurance costs. As for home insurance, you can add a couple of these things in here, general inflation, higher labor costs for some guy you want to pay to repair your living room or your kitchen or your bathroom. But perhaps this is most important. There's been a surge in billion-dollar natural disasters in the last few years. Floods, storms, wildfires. More Americans are moving to disaster-prone areas, and in a period of global warming,

more areas are naturally disaster-prone. So altogether, 2023 was a trying year for insurance companies. According to one figure from the Insurance Information Institute, for every dollar in home and auto premiums

that were collected last year by insurance companies, they paid out a dollar and 10 cents in claims and expenses. And so, in 2024, they're avenging with higher prices. And you can see this, by the way, if you just look at the stocks

of all state, progressive, state farm, Most of them had a rough start in 2023, but if you put $1,000 on Allstate and Progressive last September, you'd have $1,500 in your account today. The insurance dynamic that I've just described is not driven by one factor or another. It's about wages. It's about labor supply. It's about skills supply for mechanics. It's about car parts supply chains. It's about how you and die drive, how our driving is policed.

It's about climate change and low-pressure systems and the allure of Florida. It's about Americans getting priced out of rich metros on the coasts and moving to areas with cheaper land, but also potentially more natural disasters. Rising insurance prices are about everything. And so is inflation. Today's return guest is pretty good at talking about everything, economically speaking. Jason Furman is a professor of economics at Harvard. One of our first guests on the show, he was here to be a very good at everything. predict that inflation would become a major economic story in late 2021. I'd say he was right.

He was here to explain why inflation got so bad. He was here to explain why disinflation happened faster and more painlessly than many people thought. And now he's here to explain the mystery of the inflation pause and what might happen next. I'm Derek Thompson. This is Plain English. Jason Furman, welcome back to the show. Great to be back. I feel like a foul weather friend. You're not a foul weather friend. Well, you started off very foul weather because actually, I know that when we first had you on the show in late 2021, and you really have been with us for the entirety of our American inflation journey, that was when inflation was just beginning

lift off. And there was a lot of skepticism. I think particularly on some parts of the left, that inflation was a real phenomenon. Obviously, in the last three years, we've learned it's a very, very real phenomenon. CPI inflation spiked at 9% in mid-2020. Since then, as I've covered in the show, as I've had you back and back and back to talk about, we've had some good news to discuss, which is disinflation. The inflation rate has come down a lot in the last year. And a lot of people, a lot of economists, including me, not an economist, but I'm a person, were very optimistic about the path of disinflation, very optimistic that inflation would just keep falling. but we appear to have stalled out in our journey back to 2%.

In your own words, just take the stage here, and I'm interested in the story as you tell it, what happened to the disinflation story? Yeah. So if you're asking with that tone, you have to decide what your reference point is. If you ask me what I thought a year ago, a year and a half ago, and what most people thought,

we are still in much better shape in terms of disinflation. The underlying inflation rate, there's lots of different ways to measure it, but it's probably something like around 3% right now. And it was much higher than that. And it's come down and it's come down without a recession. So I feel pleasantly surprised compared to what Jason January 2023 thought. If you ask me how I feel compared to Jason January 2024, there I'm disappointed.

there, I'm worried about this evaporating. And you look at something like the survey of professional forecasters, the inflation we just got was 1.2 percentage points higher in the first quarter than they had forecast as recently as February of this year. That is about as big a miss as you have from them outside of the really crazy period of COVID. So things have changed quite dramatically from inflation looking like, hey, it might even be below 2% to, uh-oh, maybe it's back above three. So you asked me what happened.

I think part of it is that every time you see really high inflation, it's partly bad underlying and it's partly bad luck. And whenever you see really good inflation, it's partly good underlying and it's partly good luck. And the luck tends to go away. And so we were probably doing a better job finding all the excuses for why high inflation was transitory when we were. we should have also been doing the same mental exercise to understand how some of the low

inflation was transitory. So you mentioned the survey professional forecasters. That's the Fed's survey professional forecasters. And in February 2020, and several times throughout last year, they predicted that core CPI, core inflation this quarter, would be below 3%. As you just said, it's not below 3%. It's 4.2%. That's a meaningful miss.

That's one of the largest misses they've had in decades. Let me put the question to you this way. Why did they miss as large as they missed? What did they expect to happen, do you think, that didn't happen? Right. So inflation is always a micro perspective and a micro perspective. So there are some micro stories like auto insurance premiums are skyrocketing. That is a surprisingly large part of the excess inflation we've seen in recent months. Also, there was this hope. that the growth in the cost of what's called shelter, which includes rent, but also the implicit rent that you pay to yourself if you own your home, that that was going to slow dramatically. And that slowing has stalled out for the last couple months. And that matters especially for the CPI where it has quite a large weight. The Fed targets something called the PCE, which has a smaller weight on housing, but it matters a lot for both of them.

So you can do those types of micro factors. But I think there's also a macro story here, which is in January, price inflation was around 2%, but wage inflation was still around 4.5%. And the wage inflation was more like what you saw in a 3.5% price inflation world. And I think that wage inflation has a certain signal. It means all the pieces of the economy weren't fitting together in a way that was a low inflation. It didn't look like the economy of 1990. It did in terms of prices. It did not in terms of wages.

And the hope was maybe that was lagged and the wages would catch up. But I think throughout this, wages have been a pretty good signal. They're not affected by the same noise as use cars and eggs and insurance premiums and each one of these things that has a different story. I don't quite have that in wages. Yes, to some degree they're lagging, but to some degree they're leading. and people looking at those would have been less fooled by the disinflation than people just looking at prices.

A lot of people have looked at the U.S.'s inflation story, going up to 9% and then down to 4, 3% today, as being a part of an international story. Inflation surged around the world. Are other countries seeing this kind of stallout that we're seeing in disinflation? Are other countries seeing that it's harder to solve that last-mile problem of inflation? that we've seen. So we're the only country where the recent inflation prints have been much higher

than what was expected. Elsewhere, if anything, the inflation coming in a bit lower than expected. So we've had more of an unpleasant surprise. We also try to do something here in the United States, which is the right thing to try to do, but the data makes it maybe harder than I wish it was, which is we try to look at how inflation is changing over a very high frequency. What happened to inflation within the month of March. How does that compare to what happened to inflation within the month of February? In other countries, they almost exclusively look at what happened to the change in prices over the last 12 months, not how much did they change over the last one month or three months or six months. And it's in the United States the three and six month measures where you've had

the most whiplash. And economists like those because they give you more up-to-date information. They're not stale, like looking at price changes over 12 months, but they're also more noise. And in some sense, we just got burned by thinking, oh, there was this rapid change in inflation. Actually, it turns out maybe there wasn't a rapid change in inflation. There was a few months of noise. So in Europe, just the way they look at the data leads them to be less depressed, you know, lower highs and higher lows than we have here. You mentioned shelter inflation, and a lot of the reports that I read, a lot of the economic

interpretations that I read of the CPI data suggests that shelter inflation might be really the final boss here, that if we finally see shelter inflation come down to 1%, we'll really have a world where the Fed can begin to think about reducing the federal funds rate. What's going on with shelter inflation, as you see it? I know it's the way that it's calculated is very controversial. It's calculated in a way that can sometimes lag what Americans are actually paying for rent. That is to say that if there's a surge in new rent prices in July of 2023, it might not show up in shelter inflation for six, nine months for a variety of reasons. Should we look at shelter inflation and the fact that it's maybe the final boss here for

whipping inflation to shape and say, you know what, we should be optimistic about the fact. the shelter inflation is almost certainly going to come down in the near future. Is it an easy final boss to have? Right. So I want to answer your question about shelter. But before I get to that, I want to talk about some of the pitfalls of adding and subtracting things that you look at in the inflation measure. Two years ago, for example, if you took shelter out of inflation, it made the inflation rate

higher. At the time, none of the optimists were doing that. That was not a thing that you heard. very much about. You didn't hear about these alternative European measures that don't have inflation, because if you had, it would have made inflation higher. Instead, two years ago, what you heard a lot of is the need to take used cars out of the inflation number because they were driving inflation two years ago. Well, now, shelter is driving inflation up. But guess what? The story is reverse. Use cars are falling, their prices. They're falling at an unusually rapid

clip, one that they'll probably can continue for a bit, but probably won't continue to fall at this pace forever. And so, for example, if you look at the CPI inflation excluding shelter, it goes down and it looks fine. It looks like maybe even 2%, but you look at CPI excluding shelter and used cars, and it goes back up and looks quite high again. And so you always have to be careful, one, not to let your own biases get in the way of what you think you should or shouldn't be taking out, and two, not just telling a story on one. Now, that being said, shelter is a huge component, especially in the CPI and to some degree in what the Fed targets, the PCE. It absolutely is lagged, because for two reasons, the one that you said, which is most people's rent just doesn't change much each year.

It's only when you move that it changes quite a lot. But second of all, the statisticians, do something where they basically report a six-month moving average of it as the one-month change. And it's sort of weird and buried, but it builds a lag into even the way they calculate the number. I think there is good reason to think it'll come down further. It's come down from about 9% rate to about a 6% rate. Good reason to think it'll come down further. But I don't think it'll come down quite as far as people think for two rather wonky reasons. First of all, even though new rent growth has slowed, new rents,

cumulatively have risen a lot more than average rents. So there's still room as rents reset for them to reset up to where the new rents are, not to reset the same or down. The second is the new rents that people look at that look really optimistic and forward-looking are mostly about multifamily housing, and the growth in that has been slower than single-family. And so I think if you sort of do apples to apples, get the whole model right, I'm not counting on a dramatic slowing of shelter to save us.

I think it'll help. But then there's some other shoes that'll drop on the other foot that'll offset it. One more. Actually, I guess to summarize a bit of what you just said, it reminds me a little bit of the way that sometimes political commentators will so-called skew the polls. They'll look at a poll they don't particularly like. And they'll say, well, if you take out the fact that, you know, this cross-tab about African-American voters is clearly wrong,

Well, then the poll is actually quite good. And you're saying that to a certain extent, inflation watchers are doing the same thing, but they might be doing it even in a worse way. They're saying, well, this year, if you take out use cars, inflation isn't so bad. And then this year, if you take out shelter, inflation isn't so bad.

And then next year, maybe if you take out, you know, insurance, inflation isn't so bad. And it's important to look at the whole thing as one and not say, oh, well, if I take out any number of items from the basket of goods, that inflation isn't the problem that some people say it is. That seems like it's probably pretty good advice. Yeah.

And by the way, some of it's, it's not all bias. It's not like all bad faith. It's just if something isn't the way you think it is, you put a little bit of effort into, you know, not just updating your view, but I'm trying to figure out what's wrong with the data. And there's an awful lot that's wrong with the data and an awful lot that does need to be corrected. But, yeah, bias then can inadvertently creep in. And I think one needs to discipline oneself against them. And speaking of what's wrong with the data, so I have for a while. and I know a lot of listeners have been a little bit frustrated at me for this.

I've been arguing that there has been this gap between the hard data, which has gotten better over the last few quarters, and the soft data, so to speak, the consumer sentiment, which has lagged. That is to say, I think the economy, the macroeconomy, has gotten significantly better over the last year and a half, while impressions of the macroeconomy, especially at the national scale, American's impression of how the overall U.S. economy is doing has been a little bit more lugubrious. There was a paper that was recently published by a couple of people associated with Harvard University, Larry Summers for one, Judd Kramer, another economist we had on this show, that said, actually, the consumers understand what they're talking about, because to your point, Jason, the numbers aren't perfect.

They don't capture everything. And the point of this paper was to say that, whereas, in the 1960s and 1970s, the U.S. government trapped the cost of housing by looking at the price of interest rates that is saying looking at the mortgages, the mortgage payments who are making to their bank. More recently, we have removed interest payments from shelter inflation. And as a result, that creates a situation where we're probably underrating just how expensive this economy feels to people that are sensitive to higher interest rates. The CPI does not look at higher mortgage. It does not consider more expensive auto loans. It does not consider more expensive servicing on credit card debt. I wonder how you felt about that paper, because I'm sure it made a splash in your world, this claim that the numbers that you and I typically look at to think about what's going on with inflation don't actually capture the world that Americans live in, especially if they're making contact with new loans.

Yeah, I think there's a lot to that explanation. I remember I was talking to a columnist a year ago, who was favorably disposed towards the economy and the thesis that things are great and people don't fully appreciate it. But halfway through, they stumbled as they started to talk about how they had recently had a child, wanted to move houses, but didn't want to give up the 2% mortgage in the house they were in and how much of a problem this was creating for them. And by the way, this is someone in the data that would not show up as paying. higher mortgage payments. I don't know if they've since moved. Their mortgage actually didn't go up. It just prevented them from doing something they wanted to do. And so I felt like this colonists themselves sort of figured out some dissonance between like, hey, here's this discontent I have in my own life. I can't just scold people for being irrational and indifferent to everything. I think it is the case, though, that the world has gotten, you know, much better than it was a year and a half ago. Mortgage rates aren't that much higher than they were a year and a half ago. Inflation is, lower than it was a year and a half ago. We've had a year and a half of real wage growth right now.

So do I think everything's perfect? No, I think people are legitimately frustrated by high mortgage rates. They're also legitimately frustrated by the fact that a lot of the real wage gains you hear about and people brag about when they say real wages are up since 2019. In a lot of cases, the bulk of those gains, sometimes more than all of them came in the year 2020. And so more recently, if you look at like the last three years, three and a half years, real wage growth for a lot more people is negative. So I don't think things are quite as good as some say, but I do think they're getting better.

And by the way, you do see that reflected in the sentiment numbers, which have gone from insanely low to just somewhat low over the last six months. I think that's a good point that you have seen improvement and consumer sentiment data, but you also mentioned, I think, the really important part about what is missing when we look at official inflation numbers. And there's really two things, I think, that CPI doesn't capture. Not just one thing, as I said, on my question to you. Yes, CPI doesn't capture higher mortgage payments, and that is a pain point to people that have bought a new house, especially when their friends bought maybe a similarly sized house and are paying

significantly less in mortgage payments. I mean, frustrated about that. But also, people are frustrated if they want to move and they can't. There's no way the CPI can reflect the frustration of being on Zillow and feeling really, really bad because all of these houses that three years ago you might have felt like you could afford, now you feel like you can't afford them and so you don't move even as, let's say, you had a first kid, a second kid, a third kid, and you feel like you're spilling out of the house. There are all sorts of very real economically inflected sentiments that we can't pick up as much as we pour through CPI. I think that's an important point to make.

I want to pour through CPI a little bit more to drive toward another point related to housing costs. You know, CPI obviously looks at, you know, for listeners, it looks at a basket of goods that tries to reflect the total cost of living of the average American household, but it also reflects the annual inflation or month-to-month inflation of specific items. So, for example, you can look at this number. look at this time series and see that gas is up 1% in the last year. Restaurant prices are up 4%.

Electricity is up 5%. Rent is up 6%. Baby formula is up 10%. Golly, I know that one. Vehicle repair is up 12%. And auto insurance is up 22%. And this is where I want to pause. You know, you mentioned that use car prices are down,

but vehicle repair up 12% and auto insurance up 22%. it has become a lot more expensive, not just to buy a new house or a new car, but to own a new house or a new car. Home insurance is going up, auto insurance is going up, maintenance and repairs are going up, vehicle repairs are going up. In this category of why is it so expensive, so much more expensive these days, to own these big ticket items of houses and cars, do you have a theory of the case? Do you have a story you can tell or a number you can point to to to help explain why these big ticket items are more expensive to own now? Yeah. And just, you know this just for the sake of your listeners. The higher mortgage payments

and higher car payments are not in the CPI. What we're talking about now, auto insurance, things like that, they are measured in the CPI. So this is part of why inflation has been so high. This isn't something omitted from the data. Now, it's tricky. This is an industry that is not perfectly competitive. Its pricing is heavily regulated. So I would not have an automatic default position that the market is setting the prices and it's setting them just fine. You know, when egg prices went way up, I didn't think there was anything untoward happening. There just were, you know, chickens got diseases.

The egg prices went up and the diseases went away and the egg prices went down. And there were probably 20 other things. And I trusted that that was mostly a market. This one is not a perfectly functioning market. So I think one is right to be suspicious. That being said, the main thing that's going on here is that historically, auto insurance roughly tracks the price of cars. And when cars are more expensive to replace, insurance has to cost more because whatever damage

you do is going to end up costing more. And earlier on, we saw a big surge in auto prices, both new and used, starting in 2021. for a while, insurers were losing money, and now they're playing catch-up. And if anything, it's still the case that auto insurance is somewhat cheap relative to the sticker price of cars. So looked at from a distance, it looks, if anything, like there's both more room for this to grow, and it's not obviously unreasonable. That being said, I wouldn't mind if people took a closer look at it, asked hard questions,

because I do think it's possible that there's another policy tool going on here. but the most important thing is just the cost of fixing your car has gone up, so auto insurance is going to go up. Yeah. Also seems like people are driving a little bit more crazily and on the home insurance front, which can bleed over into auto insurance. And then you have a disaster. Sorry.

Yeah. No, it's fine. I wanted to know your sort of grand big picture theory, and I totally buy the case that as the price of the thing goes up, the price of insuring the thing goes up. I did not mention that in my open. So I think it's important. to say it. And just once again, to repeat the same point I made with Shelter, this has been a huge

part of inflation recently. But you can do a systematic procedure where you take out the 8% of items, the 8% of the consumption basket that's rising the fastest, like auto insurance, take out the 8% that's rising the slowest or falling the fastest, like used cars, and you drop those two extremes, and you're left with an inflation rate that looks an awful lot like the regular old core inflation rate that excludes food and energy. So I think this is a part of the story, but there are offsetting stories going the other direction. And regardless, this is a part of the story that I don't think we're going to get relief from very quickly. Before we go, I want to make sure that I give people a sense of what we should be rooting for,

what these numbers mean and how far away they are from a Goldilocks number. So we're like 4.2% this and 2.8% that. What are we rooting for here? Like, we don't want economy-wide deflation. We don't want all the prices to go down at the same time and for the economy to shrink. we're looking for a positive number, higher than zero, lower than 4.2. What are you looking for? What is the Fed looking for? What should we be aiming for? And when people are reading news reports about new CPI prints, what should they be anchored to

in terms of the closer to this number, the better? Yeah. Well, the problem is what people are rooting for is for prices to be the same as what they were five years ago. So prices to go down a lot from where they are right now. and I think this is something that almost every economist would agree, the only way to do that would be a massive recession. And that's not a price that I think anyone who understood the issue clearly would want to pay. So what the Fed is trying to do is take the same prices we have now, these high prices that people don't love, and ensure that they're growing at 2% a year. That's their goal. There's an open question as to what two means.

Sometimes they've acted like it means 2.0%, which is to say back when it was growing at 1.8% a decade ago, they almost seem disappointed. That's too low. We want to get it up to 2.2. Will they, if it's growing at 2.2%, say, hey, that's too high. We need to squeeze it down to 2.0. I think if they try to do that, it could actually require a big recession.

It is a level of control. I don't think they have. And then there's some unhealthy things. about inflation that's too low. At a minimum, my hope is, and we don't know the answer to this, that the Fed will interpret their target not as 2.0% inflation, but it's 2% inflation. So what is 2% inflation? Well, it's 2.4, that rounds to 2. It's 1.6. That also rounds to 2. Their tools aren't so precise. They want to get it around there. That, I think we have a prayer at getting through luck, be on the optimistic end, but a totally reasonable, optimistic.

end. I've also argued that they should raise the target all the way up to 3%. So go from 2 to 3%. They've poured cold water all over that. And I think right now they'd want to get inflation more under control before they considered any step like that. And even then they might not consider it. I asked my friend Connorsen, who's also a friend of the show and a columnist for Bloomberg, what he would ask you if he were a co-host on this particular episode. And he mentioned, because he's closer to some of these debates than I am, that the big question right now in his world is where, quote, neutral interest rates are.

That is the level of interest rate that is neither restrictive nor stimulative. So right now we're seeing pretty strong growth. And the stock market, despite maybe the last few weeks, has had pretty strong performance in the last few quarters. And that suggests that maybe neutral rates are higher than the Fed believes. Like maybe so-called neutral rates are significantly higher now than they were in the 2010s or the 2000s.

And that might suggest that we're just going to be living in a world for the next few years, maybe the next decade plus, where the cost of money is just much higher than we were used to in the first 20 years of this century. The cost of mortgages, the cost of auto loans, the cost of credit card debt, it's just going to be higher. where do you think neutral interest rates live? Yeah, so I think whatever you thought five years ago for the neutral interest rate, you almost certainly need to think something higher today. And then the open question is how much higher do you need to think? We had a Fed funds rate of two and a half percent prior to COVID,

and the economy was basically pretty normal. That is, you know, to someone from a couple decades ago, an insanely low rate. That's like what you would do in a recession to fight the recession. You'd cut it to two and a half. But instead, two and a half percent was normal. Now we have a five and a half percent rate. That is a rate that you would have thought a couple of years ago. Wow, that's crazy.

That's really, really high. But it might be what's needed. It might not even be enough to bring inflation down. And so that suggests it's gone up. Now, we're not talking about up in some crazy way in the late 1990s interest rates, the Fed funds rate was also in the fives, and that was in a relatively normal economy. So this is something that does change over time. I don't think we're at all outside of the place we've been over the last 40 years,

but we are outside of the place we happened to have been five years ago. Why would the neutral rate go up? First of all, more federal debt puts upward pressure on interest rates. Second of all, there's more demands for investment right now for things like, you know, microchips to fuel the AI boom. possibly some demographic shifts as well. Personally, I would rather more cautiously update my views. So if I thought measured in nominal terms and everything I just said was nominal terms,

it was two and a half percent before. Maybe I'd go up to 3.25 or something like that now. There are others like Larry Summers that have gotten much higher than that number. I think we often overestimate structural breaks and miss out that part of why interest rates are high temporarily to fight inflation and the inflation will go away. And when it does, the rates will come back down. But for sure, they're higher. And I worry the Fed is underestimated how much they've increased. If you look at the median of their dots, their long run forecast for interest rates, for a long time, it was 2.5. In the last forecast, that median went all the way up to 2.6.

And I think that is a, you know, I'm on the cautious end with what I'm saying. I don't like to adjust a lot, but that's barely adjusting at all. And the world does seem pretty different than it was a few years ago. I asked Josh Barrow a version of this question last week, and so I'll put it to you, government interest payments are at an all-time high right now. You mentioned that we're in a different debt world than we were in five, ten years ago. We are now spending more, the U.S. government is, on interest payments, service the debt, than we are on the military. And that has never happened before, as far as I can see in the data in American history. This might not be a hot crisis, but it could easily become something like a chronic pain

for the U.S. economy because it means we go into maybe a kind of no landing zone where inflation remains elevated. Interest rates remain elevated. But there's no appetite right now in government to raise taxes. There's no conversation in government really about cutting spending to the biggest program, Social Security, Medicare, military. And so you don't have any kind of real conversation about reducing fiscal pressure on price growth, which suggests that maybe we're just going to have a longer period of higher interest rates and a longer period of the U.S. government

devoting more and more tax dollars or deficit spending to higher interest rates. This arguably altogether makes debt reduction more important as a policy initiative than it was at any time really in decades. I mean, you sort of have to go back to 1990 when George H.W. Bush broke his promise, read my lips, no new taxes, and in fact, raised taxes. And then in the 1991,

the primary is 1992 election, you had Ross Perot and Bill Clinton talking about the deficit in a way that we haven't really talked about it in the last 30 years. What do you think it'll take for the U.S. to have a 1990 moment, by which I mean a real urgent national conversation about the need to reduce the deficit? Yeah. So just in terms of what I think the economics are here, one is the debt is on an unsustainable course. It is an open question as to how big a problem that is and how urgent a problem that is. And I'm not sure of the answer to that. And I constantly changed my mind on it. But there's also no doubt that if somebody were czar, no matter where they were from left to right, there's no reason you'd have the debt going up like this. You'd stop that from happening. Maybe you'd do it by raising taxes. Maybe you'd do it by cutting spending. You just wouldn't do this. debt path. This is done for a suboptimal political configuration. So what would change that political configuration? I think part of the politics that drove deficit and debt reduction that started really in the mid-80s with Graham Rodman Hollings, which was a failed attempt to get at this, turned into a bipartisan

agreement in 1990 and then a Democrats-only agreement in 1993 was those high interest rates. People were paying a lot for their mortgages. They were paying a lot for their cars. They hated that. And as a politician, you could basically say, if we do something about this deficit and debt, that will do something about these mortgage payments. And in some sense, the politics and the economics lined up. There actually was more of an economic problem. And the political system did more to solve it. The, you know, whereas over, you know, up until recently, interest rates actually weren't a problem. I did not think deficit reduction mattered very much five years ago,

because what did you want interest rates to go from two and a half to one and a half? Like how much good would come out of that? In fact, even some bad things might have come out of that. So the interest rate problem went away, but the interest rate problem is back. Now, the lesson from last time is it took a while. Those discussions really started in the early to mid-80s. The legislation only really passed in 1990 and 1993. And, you know, but I'm not sure that just because it took five years last time that we can count on five years this time, because we're much, much more polarized.

The no-noon taxes pledge is much more dug in on the Republican side. Democrats are probably more skeptical on the entitlement side than they were even then. And so it's a little bit hard to see our way through this, but I do feel like if we need to get through it, we probably actually will. I'm wondering if there's a former Tea Party member listening to this podcast saying, Jason, I was trying to tell your former boss, Barack Obama, that we had to cut the deficit 16 years ago. Why weren't you listening to me then? And what you're saying is, well, yeah, I wasn't listening to you when interest rates, the federal funds rate was 2.5%. Now we have mortgage rates that have gone from three to seven and a half. So it's a very different interest rate environment. It leads me, though, to my final, final question to you, which is, in 1990, I, I was in kindergarten. I was not following fiscal politics, particularly closely at the time. I was in college not following them that closely. Okay.

Were politicians really saying, like, your higher mortgage payments are the result of higher debt? There is a line we can draw between the government, not being responsible, and it punishing the ability of you and your family to own and afford the house you want. Was that line between fiscal policy and personal spending being consistently drawn in the kind of way that you just drew it? So I got to the Clinton administration in 1996 to the Council of Economic Advisors, my first time in government. And we did a lot of analysis and points and wrote lines for the president's speeches taking credit for lowered mortgage payments as a result of deficit reduction. I am not sure I know how much of an argument it was ex ante versus, oh, ex post. We saw mortgage rates go down and now we want to, you know, attach some credit to it.

So my hunch is that it was driven by, and it certainly was very correlated with the period of high interest rates. But I'm not positive how much of a public message that was, but it certainly was after the fact part of the message. Yeah, it's always interesting to feel like you've put your finger on a corner of the discourse that feels inevitable to become larger in the next few years. I feel like there's just no way in which we enter a world where neutral interest rates are higher and inflation stays a little bit higher for longer and people are frustrated about the cost of owning big ticket items like housing cars. It seems very likely to me that this is going to be a part of the conversation sometime

later in the 2020s, but I agree with you. I really appreciated the way that you put it, that the debt path we are on is unsustainable. But even though the word unsustainable sounds like a crisis, you're not yet ready to attach the word crisis to it because you don't know how crisis-y it is yet. We don't know if this is just a chronic pain will just live through, like people live for decades with hips that don't feel good, or whether this is something where we have to go to the fiscal hospital for it. I do agree with you. I think that's a sensible and right way to think about it. Last point, Jason. Yeah, and one thing that's lurking in the background is social security and Medicare trust funds are exhausted about a decade from now. If we decide we're going to do something about

that by raising taxes or cutting spending, the magnitude of addressing those two problems is about equal to what is needed to put the debt on a sustainable course if the congressional budget office assumptions are correct. So there is actually this forcing event out there, and my hope is that we use it on the fiscal side, and we also use it in the right way. I have a lot of preferences over how social security gets reformed to strengthen and help the program, not just cut benefits in ways that I would rather not see. All right. Great. Well, as our messenger of doom, maybe the next time we have you on won't be to talk about how we're disappointed at the path of disinflation. It will rather be about how to reform social security. Jason Furman, thank you very much. Thanks for having me.

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