The Dispatch Podcast - What Are Economists Actually Good For? | Interview: Doug Holtz-Eakin

Episode Date: May 27, 2024

Doug Holtz-Eakin, president of the American Action Forum, joins Jamie to discuss the role of an economist and recession predictions. The Agenda: —Explaining why a recession hasn’t come this year ���The role of the Federal Reserve in managing inflation —Rent prices and housing stock —Education reform and a pro-growth tax code —The breaking point with interest rates —Will the U.S. dollar stop being the reserve currency of the world? —The economic impact of defending Taiwan against China Show Notes: —Minutes from the latest Fed meeting —Latest Consumer Price Index (CPI) data Learn more about your ad choices. Visit megaphone.fm/adchoices

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Welcome to the Dispatch podcast. I'm Jamie Weinstein. My guest today is Douglas Holtz-Ekin. He is the president of the American Action Forum. He's also a PhD economist who previously served as director of the Congressional Budget Office and was chief economic policy advisor to John McCain's 2008 presidential campaign. For a change, we talk economics in the state of the economy, as well as what is going on internationally, particularly in Argentina, and what might occur to the U.S. economy if China in Taiwan ever engaged in war. So we get into a lot of different economic topics. I think you'll find this podcast both different than our usual fare over the last several months and also very intriguing. You may, while you're listening here, sometimes the audio

changed slightly. We had a couple technical difficulties recording this. I don't think it will herm your listening experience very much, but you might notice it. So I just want to point it out. So without further ado, I give you Dr. Douglas Holtz-Eken. Douglas Holtz-Eken, thank you for joining the dispatch podcast. My pleasure. Thank you. Well, we haven't talked about economics on the dispatch podcast in some time. So I wanted to bring in an economist here to talk about, which is probably a pretty rather important subject, which is the economy. So I want to begin with this Harris poll that

was released earlier this week. We're recording on Thursday. It showed 55% of Americans believe the economy is shrinking and 56% think the U.S. is experiencing recession, even though GDP has been growing. It shows that 49% I believe the S&B 500 stock market index is down for the year, even though it's up about 12% and up about over 50% in the last 18 months entering a new bull market. I think we're at new highs today as we speak. 49% believe that unemployment is at a 50 year high, even though unemployment rate has been under 4%

for quite some time near a 50 year low. How do you square the poll of what Americans think is occurring to some statistics showing that stock market at least in economic growth that is growing. Well, let's begin by simply not paying too much attention to the stock market. I really don't, except over the longer periods of time. Here's the setting. We came into this year with a business community that was actually not spending a lot of money.

Looked at the last two quarters at 2023, business fixed investment was pretty weak. And that's the normal sign of entry into a recession. every recession in the post war except the pandemic started with the downturn of business spending so i was concerned about the state of the economy but households are spending hand over fist we get the first quarter data and it actually is really good it's balanced between households and businesses and we grow at 1.6 percent which is solid but that's really dampened by some one-time inventory movements and trade movements so it's a pretty good money and i was feeling fairly good about the outlook for 2024 and in april so that's january february march and

April, households seem to have hit a wall. We saw some really bad numbers. The service sector contracted, employment in the service sector contracted. Credit card spending grew by half of what it normally does in a month. Retail sales were dead flat, so adjusted for inflation, they're down in real terms. Consumer sentiment, sort of at the heart of the Harris Bowl, drops 10 points for assessment of the current situation and is below the worst of the pandemic. And so households really are not feeling it,

and now they may also not be spending. And they were supporting the economy for a long time. So there are some cracks appearing in the economy, and I think that's caused their concern. An absolute recession, that's too strong. And I think the notion that the stock market's down, they're just not paying attention. Unemployment's very low.

But I think the stress of sustained high inflation, sustained high interest rates, is really showing up, particularly in the lower-income household sector. I think what is a little bit shocking, I found this chart here, and this, to me, explains it a little bit, and I like your comments on it.

This is a chart I'm holding of fast-feed prices from 2019 to now. A cheeseburger at McDonald's cost about $1 at the end of 2019. It costs $3.15 now, which is a $215% increase. The average of all the items on this chart are about 80% increased Is there anything to counteract if you're, you know, President Biden?

I'm sure he wants to go out there and tout these, you know, at least on paper, great economic numbers. Can anything counteract what inflation has already done, even if it moderates? Because it doesn't mean the prices are going down. It just means, can we get back to 2%? They're going to go up much less than they were every year. Yeah, I think he has a real problem. If you look at the growth in wages and the growth in prices,

prices of outstripped wages through his entire first term. And so, with unemployment very low, that means every's out there working, falling further behind every day. And that's incredibly frustrating. And it shows up, and all the polling shows up in these consumer sentiment numbers. And if you're spending money on a subset of the goods that is fast food, or just food, energy, shelter, that inflation is higher than the overall average. So people are really feeling it. You know, almost every economist was predicting a recession. And the recession never came.

Why? First of all, how good do you, I mean, are we asking economists to do too much? I mean, is it their job to predict these things? And it does seem that we usually don't get, you know, whatever be consensus with the economists sometimes, it usually would be opposite that occurs. Is it right to be, I mean, is it worthwhile to ask economists predict these type of things? And why don't you think we got a recession that so many people thought would come? So it's worthwhile to have people explain their thinking, if they come to the conclusion, there's going to be a recession or not, but what's more important is what are the factors that are leading to that conclusion?

What strengths do you see? What weaknesses do you see? What would change your opinion? I am among those who thought by the end of 2023 we were likely to be in a downturn. the the basic recipe for that is you've got really high interest rates we had business spending that wasn't particularly strong given the cost of financing you don't then do an expansion of the plant you don't then do a merger and acquisition all of that stuff falls off and eventually you start laying some people off and that's when the household sector starts contracting but we didn't see that and I think

There are some tiny countervailing factors that turned out to matter. There's been a lot of business investment in two areas. One, the government has just bought a lot of manufacturing investment with the green energy tax threads. And you can see that in the data. And the second is AI. And the Vidiya chips and investments in AI were enough to keep the sector afloat. And households in the end carry, spent money hand over fist in a way that most people didn't anticipate. There was a lot more leftover savings from the pandemic checks and things than had been anticipated.

And so, you know, a greater willingness to spend out of the business sector, a greater capacity to spend out of the household sector. We all sort of missed it despite the high rates. But it may be that we missed it by six months because we're now starting to see the kinds of things we were worried about at the end of last year. There was one thought that because businesses post-pandemic had so much trouble getting people, and the cost of getting impired, that even as things might turn a little bit and might, you know, in a normal environment, have them lay off some workers. They kept workers on because it was just so difficult to get them to begin with. And as long as you have people employed, they keep spending and therefore it's hard to go into recession. Do you buy that theory?

There's something to that. A different way to say the same thing is there's really a total demand for labor, that is, people you've got on the payroll and unfilled vacancies. And the unfilled vacancies were enormous. Like, we had many more unfilled vacancies that we had unemployed people for a long period. And so the way the Fed has tightened the labor market is not to have people to get laid off. It's to say, okay, I'm never going to fill that fix. We're just going to take that job off the board. And so we've seen that come down dramatically to levels that are back to the pre-pandemic levels. We just haven't seen real layoffs. Now, I will point out. Unemployment is a half a point higher than it was a year ago. And in most circumstances,

that's a harbinger of a slowdown and ultimately a recession. How do you rate the Fed, how they've handled this? Obviously, a lot of people blame them for not seeing inflation coming earlier. If this turns out to be a soft landing, although it sounds like you think that maybe it's too soon to say that, will Jerome Powell get credit for that? I think he should. You know, the Fed's records next. They made some really big policy errors in 2021 that, that in part produced this inflation. There's no question about that. They were slowed to turn to tightening. But once they've started tightening in 2022, I think they've done as good a job as you could under those circumstances. The reality is, once you let inflation get embedded into an economy, you have no good choices.

You either live with the inflation. People hate that. Or you do the kinds of things necessary to get rid of it, which is raise interest rates, slow down mortgage applications, slow down home building, slow down retail sales, stop hiring. Those are all bad news stories in and of themselves, but they're necessary to get the inflation under control. So the Fed's always in a terrible position. What bad news am I going to deliver? I think they've managed it pretty well. Will they pull it off and then have a soft landing? I think the odds are still stacked against them, and historically that's really hard to do. But you know, you can't tell given the data right now. I'll just point out that every hard landing starts as a soft landing,

and then things go south. So keep your eye out. I've seen some people argue that the Fed was right when they were saying that inflation was transitory, and there was a supply chain. It just took longer than they thought, that the hikes might not have been what caused inflation to come down.

It was supply chain, just working inflate. What do you think of that? The timing's not right. You know, the key inflation right now is shelter. It's the rents you pay in your apartment and the sort of implicit rents you have in your house if you own. Those apartments are not coming to us on containers from China. They're here.

There's no supply chain. So the inflation we have now is what's left over from demand. And that demand was from excessively lose monetary policy and excessively lose fiscal policy. And we've reversed the monetary policy. The fiscal policy you still have $2 trillion deficit at full employment. That's terrible macro-manage. in the big picture. So that supply chain thing doesn't match, given the location of the inflation, the timing

also doesn't work out. If you look at, like, producer price indexes, things that you would suspect would be indicators of supply problems, they've been at 2% or under for a year. I mean, there's no evidence of any supply chain problems left. Just on the apartments, I mean, they don't come on in a supply chain, but the wood to build new apartments might. And isn't that possible? And the cost, obviously, of wood went up dramatically.

But that's a tiny increment to a very big housing stock. That can't explain the fact of all those existing apartments costing so much more. That was just people having more money and want to have a nicer place. One of the issues that Barry Sternlich has had with the Fed is that they use kind of lagging indicators. He knew that apartment rents were going up before the Fed recognized it. He now says that they've been going down before the Fed is turning on it. Do we have a problem with the data the Fed it uses to determine these prices?

Can it be more real-time than it is? No, I don't think we have a problem. I mean, the official data are economic history by the time we were looking at them. No question about that. They come in a month late. Sometimes you get the quarterly data to even older than that. And those are important indicators of the state of the economy. But if Barry has access to real-time data, so does every Fed governor.

And the Fed, before every meeting, goes out and does its surveys for its base book, which is, let's go talk to people on the ground that every Federal Reserve District, ask them what's going on in the economy, consumers and businesses like, is it hard to hire, easy to hire? They've got access to real-time information. It might not be the systematized consumer price index, but they've got as much information as anybody. It's just really hard to judge a $25 trillion economy,

the pace at which the many different sectors, are expanding, contracting, and, you know, it's really hard to judge the impact of monetary policy. I mean, think about it. What does the Fed do? By and large, it raises the federal funds rate, which is the interest rate, it pays on reserves to banks or the overnight rate between big central bank, big money center banks. So that's the shortest credit in the world, overnight lending. And they just push that up and they watch it bleed out to every kind of credit, mortgages,

autos, credit cards, and every duration, three months. a year, five years, 10 years, that's a pretty imprecise crude implement for monetary policy. And Milton Friedman is famous for saying that monetary policy works with long and variable lags, which is just a very nice way of saying, we have no idea what's going on. So, you know, they push it up, they watch, has it had an impact? Is it done having an impact? Do we need more? Do we need less?

A lot of uncertainty associated with the use of their instruments. In this circumstance, we've got open warfare in the Middle East and in Ukraine, we've got China with a very dicey trajectory coming out of the pandemic. The environment's pretty uncertain. So I think they've navigated it as well as they could. It's just a very hard job. I should note for those who might not know, Barry Sternlicht is the head of Starwood owns thousands and thousands of apartments.

Sure. And by the way, he's free to pick up the phone and call Jerome Powell. And Jerome Powell take his call. They appreciate that information. We saw that. And we're factoring that into our decisions. Do you think, I mean, it sounds like you think, think the economy might be turning. So do you just expect that rates, that the Fed will begin

to lower rates as I guess a lot of people lost rate hoped earlier this year many times, but at least a few times this year? So the Fed just released the minutes of its most recent meeting, which displayed all sorts of angst about three months of hot inflation readings they've gotten. The day after that meeting, we got the CPI, and it came back on trajectory toward two. So some of that angst might have been alleviated if had they known those, those data. But when the discussion turned to the labor market, they were quick to note that they would cut as conditions required it. So there's a bias toward cutting if the, if the real economy softens. And I think the more important question is not when will the Fed cut, but why is the Fed cutting?

Is it cutting preemptively in the anticipation of having a soft landing? Or is it cutting? that are looking out there and there's trouble. And I'm more worried we might be cutting it for the wrong reasons later this year. If they do cut, I mean, I think a lot of people wonder, will we ever, I mean, obviously we were for a decade at the zero percent Fed rate, will we ever get back close to that? Will we ever see as a corollary to that, you know, 3 percent, 4 percent mortgages again? Yeah, I don't anticipate that. I mean, I don't see that period remains somewhat of a mystery. I won't pretend to have coherent explanation for how we ended up there, but, you know, at this juncture, there's no real evidence that we're

going to go back to zero interest rates. We've got embedded inflation, which has its own momentum. It's hard to wring that out of an economy. We've got, in my view, fiscal policy that's just way too loose for where we are, and none of that suggests going back to zero. Not long ago, I saw someone go through a sudden loss and it was a stark reminder of how quickly life can change and why protecting the people you love is so important. Knowing you can take steps to help protect your loved ones and give them that extra layer of security brings real peace of mind. The truth is the consequences of not having life insurance can be serious. That kind of financial strain on top of everything else is why life insurance indeed matters. Ethos is an

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A topic that's so rarely discussed anymore, it used to be discussed a decade ago so much more as the national debt. And how concerned, I mean, we have a $34 trillion national debt. You mentioned the government spending is one of the reason the economy is still. We're still spending $1.7 trillion in deficit spending. despite having, you know, a fairly booming economy, at least by GDP metrics. How concerning is the national debt to you? I'm terribly concerned. It's at record highs.

We're at 100% of GDP, roughly speaking. It's projected to go nothing but higher. You know, the combination of the large debt, the large deficits, the activities of the federal government, I think are cumulatively an enormous headwind economic. growth. So here's the numbers to bore your listeners. In the 20th century, GDP per capita, a crude measure of the standard of living, income per person, it averaged growth of about 2.4% per year. And the standard of living as a result would double every 29 years. That's roughly one working career. That's what gave people access to their version of the American dream. In the 21st century,

it's averaged 1.4% per year, which means the standard of living doubles every 56 years. And there is this palpable sense in polling and other discussions of the economy of Americans not having access to the opportunities that their parents had, that the American dream is out of reach somehow. And I think it's not a coincidence that in the 20th century, we managed fiscal policy to keep the debt at roughly 30% of GDP and relatively stabilized it. And in the 21st century, it has only gone up. We have shown no political economy wherewithal to stabilize the debt relative to GDP, and it continues to go up. That's a real headwind economic growth. And we are paying a price for it a little bit every year and cumulatively quite a bit. Had we kept growing at the

20th century rate, there'd be GDP per capita for everyone of another $19,000. And I would like my 19. I don't know about you. We'd have $1.2 trillion more in revenues, so the budget deficit would look a lot different, that poor growth performance is a big problem. And the way we've handled the budget is a big chunk of it. So I think we need to get serious about that, but so far, no one really is. I guess the question is, you know, it's always theoretical. And, you know, eventually something's going to have to break. At some point, not too distant future, interest payments are going to exceed what we spend on everything else. Already happened. Already happened. What happens? What happens when things break? What does breaking look

So there are two kinds of breaking. The breaking that everyone focuses on is the sovereign debt crisis where international lenders just take a look at the U.S. and say, well, I don't believe you're going to pay your money back, especially on the timely fashion. They cut the U.S. off. That's the Greece, Portugal, Argentina version of things. And that's very, very bad. There's no question about it. You get a cutoff in credit. Interest rates spike up. You'd have to do a lot of austerity, instant big tax increases, huge cuts in spending, generate a large risk. session. And so you have it just a crisis on all fronts, domestic international. That's not imminent in my view. There's no reason not to avoid it. That's for sure. But the other way it breaks

is just a little bit every year. And that's the part I'm worried about. It's the fact that we are, the federal budget is really designed to subsidize consumption. So if you look at the federal budget. Over the next 10 years, we'll spend $82 trillion of that. The things Congress does every year are trivial. They're 20 trillion of that. 50 trillion of it is so-called mandatory spending, of which 32 is Social Security of Medicare, those big entitlement programs. The point of Social Security of Medicare is to have the elderly live better in retirement. It is subsidies to their consumption. Most of the rest of the budget is subsidies to consumption of one type or another. And so the way you grow is not complicated. You don't consume.

You save, you invest in skills for workers or new business models or equipment or software, whatever it might be, and you have greater productivity in the future. But as a nation, what the federal budget does and says, no, we don't do that. We take resources and we tell you to eat now, consume. If you overdo that, you're not going to grow, and we're not growing. And so I think what needs to be done is to sort of recognize the tradeoff and just put a little more into the saving investment growth category and a little less on the subsidized consumption. that means getting the budget steps down,

getting the federal spending more closely aligned to reality. The first threat, you mentioned, which you don't think is likely in the near term. Is it possible for something like that happened while the U.S. dollar is the reserve currency of the world? Yes. Yes. That's how you stop being a reserve currency.

People don't want to hold the dollar anymore. But is there any chance? I mean, I guess people point to the challengers would be the yuan, the euro, and Bitcoin, and none of those seem, you know, realistic. Right. So in economics, everything is relative. And so the U.S. is a mess.

and the dollar is, as a result, under question. But where are they going to go? I mean, as it turns out, we're the best-looking horse in the world Blue Factory, and so when things go bad, the money runs to the U.S. still. That's why I don't think that version of the crisis is imminent. We have different kinds of crises that we have to deal with. So take Social Security. Social Security is supposed to exhaust, run out its trust fund revenues in 10 years.

We're not doing anything about it. Both people running for president said they're not going to touch it. But when it exhaust, there's an across-the-board cut of 21% to everybody in retirement. That's unthinkable. We're not going to do that to retirees in the United States. And so Congress is going to run in and fix it at the last minute, if not before. And so the cut won't happen, but we don't know what will happen. And so if you're 55 and plan to retire in 10 years, you have no idea what your Social Security is.

You can't make a retirement plan because you have no idea what you'll get. That's a terrible way to run a pension program. And that's going to produce, I think, more and more political upheaval as we approach the date. And Medicare is bleeding, red ink, that's true. There are a lot of young voters who can't get the government to anything they want because the money's all spoken for by programs that were designed in 1965, and that's irritating to people. We keep having showdowns over debt ceilings. There's enough problems on the home front that we don't need the international crisis to sort of start driving some change to this.

If you were put in charge or king for the day of the United States and were allowed to an act, three economic policies that would put us on the ship to once again lead the 21st century, like we led the 20th century, what would those policies be? Policy number one would be to fix the K-12 of education system, which is a national disgrace. And is also evidence we're not preparing the workers for the future labor force and we won't have the productivity and they won't have the lifestyles

that we expect and want them to have. And so that's number one. That's a huge problem. It's not being dealt with, has been dealt with for a decade. Second would be take on the entitlement spending programs. The key there is they're big, but worse, they grow faster than everything else. So security grows at five and a half percent per year over the next 10. Medicare at seven.

They have to come down and grow at roughly the pace of the economy. And that's going to be four, you know, 2% real plus 2% inflation, something like that. So slow the growth of those programs. that that's that's all you need to do just get them to grow more in line with the growth rate of the resources and then um you know we're going to need to have more tax revenue so we have to have a better tax code that's more pro-growth and supports the revenue needs of the federal government those are three things they're all big they're all hard we need to do them if you can just elaborate on the first and the third what would what needs to be done to the k through 12 uh education system

yeah so i'm not a i'm not an education special so i'm not going to pretend to be what on your podcast, but we do a national assessment of educational progress every year. And for 10 years prior to the pandemic, roughly a quarter to a third of fourth and eighth graders were seriously deficient in math and reading. They were never going to recover. And it got worse in the pandemic. So we went 10 years without taking care of something like 25 to 33% of the future labor force who are not going to have the skills to actually go out and be effective. And now it got worse, and I still don't see anyone running for president saying, hey, you know, this is important. We've got to do something about this. There's radio silence. We're talking about all sorts

of silly things, but that is important. And I don't know how to fix that off the on my head, but I think it's disgraceful. We're not even worried about it. That seems really wrong to be. So that's number one, and what little I have to offer. Number three, you know, a pro-growth task code is one that rewards saving investment in growth or it doesn't overly penalize them. You have to tax something, so you're going to tax everything. But don't double tax corporate income, for example, get a unified system that taxes a business income once and only once at an effective rate. Don't have a lot of tax loopholes for consumption. Like we have mortgage interest deductions. They are there, and they help the more affluent, consume more

house. I don't think the road to future productivity lies in bigger bedrooms and living rooms. So, you know, let's let's get the tax code to focus on the right things and raise the revenue that we need. Low rates, broad base. Let me ask you just two questions from the The International scene. One of your thoughts on Javier Mele in Argentina, what he's doing there. What do you think of that? I find it fascinating and mesmerizing. You know, during the, I'm not a kind of sort of Argentine politics, but, you know, as he was running for office, you thought, okay, I have seen these sort of carnival shows before that he's going to run into reality if he ever gets elected. He's done really well. He's made some very large changes in a short amount

of time pretty successfully, at least to my eye. And it is worth watching because it's just an example of he talked about dramatic changes we're going to get rid of half the agencies and half the departments. And he's probably not going to do that, but he's right-sizing things. They, you know, things that were too big are getting brought down to the right size.

He's trying to have a sensible monetary policy and fiscal policy that match up. You know, good for him. There was just recent a new president of Taiwan. China is obviously unhappy with his inauguration speech. They released a statement today. Taiwan independence forces will be with their heads broken and blood flowing after colliding against a great undertaking of China, achieving complete unification. What would happen to the U.S. economy if China decides to invade

Taiwan, you know, we either respond by supporting Taiwan or actually engaging in the fight herself? So the first question is, is the loss of Taiwan an economic, economically significant event for the U.S. economy? The answer is no. I think at this point, private enterprises, chip manufacturers, in particular, recognize the risks that are Taiwan and would diversify their production elsewhere. It's just as a matter of protecting themselves. Those eventualities are not the ones I worry about. Armed conflict between the United States and China is a very big deal.

Putting the U.S. economy on a wartime footing for that kind of an opponent is a very big deal, and that's what we would be doing. And so that's going to be simply not an economic event. it'll be a geopolitical event and an armed conflict that I think would be best to avoid. How about something short of that, something like we saw, what the U.S. did with Russia after the invasion of Ukraine, where we force companies to withdraw from China. How would that, I mean, that's not quite war, but it's...

Yeah, I don't think, you know, that if we had to withdraw from China, and indeed, we're already doing that, that's going to be real pain. These are the two largest economies in the planet there, deeply intertwined. There is no decoupling, like just simply not doing business with China that is economically easy or quick. And so if you did have a forced severance of all business relations with China in, you know, like a month, that's really bad news for the U.S. economy. I think that that's a serious change in production supply chains, distribution networks, you name it. And you'd see a whole bunch of different shortages. You'd see it be a whole bunch of different costly reworkings of supply chains.

And anytime you have to have a big costly change in something, it harms overall economic growth. That's a negative, those big costs. And just finally, I mean, I guess on China's side, that would be pretty costly for them as well? Absolutely. Potentially more costly. Potentially, very costly. They have not been successful in generating a vibrant domestic market and rely exclusively on exports now for their growth.

I mean, that is, again, the strategy. Everyone thought they would outgrow that, stopping export-led, starting to... Xi is, once again, pushing an export-led strategy. That would be, you know, if there was that kind of conflict, the U.S. would try to rally all of its allies

to stand unified against the Chinese and break off their relations as well. China isolated and unable to trade is a China that's in very bad shape. Douglas Holtziken, thank you for joining the Dispatch podcast. My pleasure. Thank you. You know,