The Munk Debates Podcast - Munk Dialogue with Mark Zandi: avoiding a recession with smart policy decisions

Episode Date: April 11, 2023

With inflation remaining high despite rising interest rates, many economists are looking for new solutions to bring inflation down without triggering a recession. On this Munk Dialogue, we’re joined by Mark Zandi, chief economist of Moody's Analytics, who gives us some insight into why the situation might not be as dire as some believe, and offers up some proposals on how to get inflation under control without raising rates.   The host of the Munk Debates is Rudyard Griffiths - @rudyardg.   Tweet your comments about this episode to @munkdebate or comment on our Facebook page https://www.facebook.com/munkdebates/ To sign up for a weekly email reminder for this podcast, send an email to [e-mail].   To support civil and substantive debate on the big questions of the day, consider becoming a Munk Member at https://munkdebates.com/membership Members receive access to our 10+ year library of great debates in HD video, a free Munk Debates book, newsletter and ticketing privileges at our live events. This podcast is a project of the Munk Debates, a Canadian charitable organization dedicated to fostering civil and substantive public dialogue - https://munkdebates.com/   Senior Producer: Ricki Gurwitz Editor: Kieran Lynch Become a Munk Donor ($50 annually) to get 72-hour advanced access to the full length editions of Friday Focus and Munk Dialogues. Go to www.munkdebates.com to sign up. Hosted on Acast. See acast.com/privacy for more information.

When you're a journalist and people don't trust you, it's always your fault. These people need to be represented. They are Canadian. They deserve to have a voice and a seat at the table. It is time to go back to the office, and the time is now. Russia had reasons to be concerned. They had reasons to be fearful. We're at an absolute turning point in reproduction. This is the problem with realism. They just treat all countries the same. They don't distinguish between dictatorships and democracies. Hello, Monk listeners. Rudyard Griffiths here.

your host and moderator, welcome to this, our continuing conversations called the monk dialogues. These are in-depth questions and answers with some of the world's sharpest minds and brightest thinkers. We go deep into the big issues that are transforming our world and shaping our future on each and every monk dialogue. Today we're talking about the R word. It's called recession. We know it well. We fear it. There's been a lot of whispering in financial circles lately. is the Canadian-American and economies of the developed West heading towards a recession as a result of record high interest rates and an economy that is having to cope with the effects

of a war in Ukraine, increasing geopolitical tension, and most recently a string of high-profile bank failures. Well, for answers on this monk dialogue, we're going to be joined by Mark Zandi, Chief Economist of Moody's analytics. He's going to share his insights into why the situation might not be as dire as some believe. The cup may in fact be half full, not half empty when it comes to the economy and the recession risk we now face. Mark Sandy, welcome to the Monk Dialogues.

It's going to be with Steve Rudyard. Thank you for having me. Really looking forward to this conversation so much to dig into. Let's start big picture, though, Mark. You're a big picture thinker. How would you characterize the current state of the global economy? It's struggling and struggling with very high inflation for lots of different reasons, but most notably because of the fallout from the pandemic and the Russian invasion of Ukraine. And, of course, with the high inflation, central banks like the Federal Reserve have been raising

interest rates very aggressively to combat it. So in a world of high inflation, high interest rates, you know, putting pressure on different parts of the financial system. We've recently seen that with the problems in our banking system here in the U.S. So, you know, the economy is growing. We're creating still a lot of jobs, unemployment's low, but I have to say the economy is struggling, and there is a fair amount of concern about recession risk debt ahead. So, Mark, one of the things that I struggle with is this idea of, in fact, what inflation signal? I mean, it signals to me an economy that has a surfeit of demand and an absence of supply.

In other words, the economy, am I right, it's strong out there. There's a lot of demand. People seem to want to go to restaurants. They want to travel. Maybe some of that's post-COVID. But it seems like, especially in the United States, your labor market, incredibly resilient here. So what's that all about? How do you think about this Venn diagram of, you know,

the job market, attitudes amongst consumers, inflation, and then monetary policy, supposedly putting all those pieces together into some kind of coherent strategy. Well, inflation, you put your finger on it. It's, you know, if you went to the Econ 101, it's demand and supply. It's nothing more complex than that. And the demand has been strong. You mentioned the labor market in particular. Demand for workers has been very strong. But the supply side of the economy, I think, is the principal reason for the high inflation. We suffered globally two massive hits to the supply side of the economy, the pandemic. And that's winding down, obviously, but it's still affecting supply chains around the world.

So I'll give an example. In the vehicle industry, new vehicle prices continue to go skyward. And that's because production of new vehicles in Japan and Germany still are well below pre-pandemic levels because of supply chain issues. Labor markets are still disrupted by the pandemic. Immigration only recently has come back. And of course, in the United States, we rely very heavily on immigrants of all skill levels to support businesses across the board. And then the Russian invasion of Ukraine, that too, the fallout is fading, but you were still grappling with it, the higher energy prices, the higher food prices, the higher metal prices. And then what happened is these two

shocks conflated and caused inflation expectations. That's what people, businesses, investors think inflation is going to be in the future to rise significantly. And that's when the inflation kind of metastasized across the economy. That's when the Federal Reserve and other central banks went on high alert and started raising interest rates very aggressively. So, you know, the high inflation, it's demand and supply, no doubt. But if I had a rank order, I'd say at the top is these massive supply shock. It's what makes this period so unusual compared to any other, most other periods that we've lived through.

Now, we've seen Mark some cooling in inflation. It's not kind of completely come off, but we're starting to see in certain kind of key parts of the Consumer Price Index in the United States and Canada, too, reductions in the rate of inflation. How do you think this plays out? And I guess I want to test you on this. argument that's out there that it's great that inflation's coming down, but these central banks, Canada, the U.S., have these 2% inflation targets. So some people are hypothesizing it's easy

to take inflation down that first leg, but then when you start getting, you know, three and a half, three percent into the twos, that's potentially mark where, I don't know, are we contemplating the potential here for banks to have to stay higher for longer with their interest rate? hikes in order to really bring that last sticky part of the CPI down into the range that they're comfortable with. Do you subscribe to that thesis or do you think inflation is just going to come off more naturally, maybe without the necessity of keeping rates higher for longer? Well, I think you laid that out nicely. I do think inflation, just to give you a number to make this concrete. So consumer price inflation in the United States peaked at 9% on the nose year over

year last summer, June of 2022. As of February of 23, we're now down to 6%. And I do think getting down to 3% over the course of the next, you know, 9, 12 months, probably pretty straightforward. A lot of that will go back to those new vehicle prices I just talked, talked about the easing of supply chain issues more broadly. And the cost of housing services will also moderate very significantly. That ties back into rents. And rents have gone flat to down in many parts of the country because we're seeing a lot more supply of rental property and less demand because rents are so high. It's called demand destruction. Households aren't forming. So getting from six to three, particularly with oil prices where they are, I think that's very doable. Getting from three down

to two to two and a half, and that kind of is the target for the Fed. C.P.E. inflation is probably closer to 2.5% than 2. But regardless, that last mile, that will be more difficult. And that goes to the cost of various services in industries that are very labor-intensive, healthcare, hospitality, personal services. And so that goes to wages. And getting wage growth back down to a place where businesses in the service side of the economy raise their prices less aggressively is going to be more difficult without the Fed kind of

miscalculating, other central banks, miscalculating and pushing the economy into recession. So that's the crux of the matter, and that's going to be tricky. And I think under any scenario, it's going to be uncomfortable. But, you know, I think it's doable. You know, central banks with a reasonably good policymaking. And I'll throw into the mix also some reasonably good luck. We can't get nailed by something else, which, you know, obviously, that's a tall hoarder, particularly given our luck in recent years. But, you know, we're very vulnerable in this environment. So if anything else goes wrong, we're going into recession.

But if we're able to get through with a little bit of luck, some reasonably good policymaking, I think we get that inflation from three down to two, two and a half in a reasonably graceful way. Here's the other thing I'd say is, I'm not sure I get so exercised. You know, if I were a central bank about getting from three to two to two and a half, you know, maybe take a breath and maybe we'll get there in a year. year, year and a half, I don't think we need to get there in three to six months. You know, we don't need to go into a recession. So I'd argue, you know, let's be a little bit more relaxed about that. I don't like the high inflation. I don't want to get it in, but I wouldn't sacrifice the economy

to the altar of a two to two and a half percent. By the way, there's nothing magical about two to two and a half percent. That's just a number that central banks picked. And I think if they had that opportunity to choose that number again, it would not be two to two and a half percent. it'd probably be closer to three. Just because when you're a two, two, and a half percent, it's very easy for, you get into worlds where interest rates have to go to the zero lower balance, the zero.

And that's a very uncomfortable place to be for lots of different reasons. So my point is, you know, let's just, if we get to three, maybe we can declare victory okay and, you know, take our time to get down to two, two and a half. Do you think that there's a need here, Mark, to think through maybe some of those fundamentals

about targeting inflation at 2%. I mean, there's conjecture here that if we are moving into more of a supply-constrained world, if we're moving out of a different decade before where supply wasn't really a problem, into one where it could become persistent with reshoring, with new geopolitical tensions, is a 2%, 2.5% inflation target really the right target? Should central banks instead be targeting something higher? I mean, that's slightly scary to people because if you're not seeing returns on investments, on capital that, you know, reflect the erosion of inflation on your currency, on your purchasing power,

it makes people nervous. But is that maybe mark where we're ultimately headed to a world of three, three and a half, four percent inflation? Well, you know, if I were king for the day, I'd probably go to three. And what really matters is it's three and it stays there for a while and let's everything else adjusts, you know, wages adjust, interest rates adjust, and then there's nothing to worry about. I mean, there is an adjustment cost, perhaps, but that's temporary and no big deal. But I don't think any central bank is going to even contemplate, and certainly the last thing they're going to is even suggest that they're thinking about stopping at three as opposed to,

because as soon as they do that, then they are going to make people nervous, and inflation expectations will rise, and we will have an inflation problem, getting inflation back down. to even that 3% target is going to be difficult. So the Federal Reserve, other central banks are going to talk very, very tough until they get, you know, what they get inflation back in. And, you know, maybe it's possible. We get to three and they take a look around. They say, hey, let's stay in three. I say the odds of that are less than even. Just knowing central bankers and folks at the Fed, I don't think so, but possible. And I think it's something worth, you know, seriously considering between now and when that opportunity does, you know, presented some. off a year or two down the road. Let's talk about some of the known unknowns out there. You were recently testifying Congress on debts and deficits and the U.S. kind of fiscal position. We just had another budget here in Canada.

Again, record deficits out really for years. No clear discernible plan to go back to balanced budget. Some people are hypothesizing, Mark, that this is concerning because right now is a moment where arguably probably tax revenues are pretty high because the economy is pretty strong. And you've also got a, you know, a situation where unemployment benefits, payouts are low because, again, you don't have the social safety net having to respond to a big economic slowdown. Are you concerned about this seeming inability maybe for governments to make an adjustment to this post-COVID world of returning to something approaching debts and defts?

as it's, you know, which already were kind of negative pre-COVID, but weren't excessive in the same way that they seem now. And this seems like a trend not just in the United States and Canada, but across much of the advanced economies. Yeah, I'm worried. I mean, Canada is probably the best-managed large economy on the planet. So, you know, you've got your problems in Canada, but our problems are much bigger than yours, you know, probably 10 times bigger than yours if you just look at the population. I mean, we've got some big issues. But just to, again, Again, to give you a number, to give you context, the debt to GDP ratio, so if you take all the government debt, publicly traded debt, divide by GDP, the value of all the things that we produce,

that's pretty close to 100%, not quite, but that's kind of where we were. By the way, for most of the post-World War II period up until the financial crisis, which nailed us back in 0809, the debt to GDP ratio averaged something like 40, 45%. So that gives you context. The Congressional Budget Office, which is a nonpartisan government agency that does the budgeting and forecasting for the budget here in the U.S., did a recent outlook in assuming no change in policy going forward. So you just take current policy as written into law, which, by the way, does include the expiration of some of the tax cuts under President Trump. That's in law. the deficits will be large and the debt to GDP ratio will go from just under 100 to close to 120% 10 years from now. And then, of course, the world doesn't stop 10 years from now if you keep going out.

You can take the trend lines. You know, those trend lines get, so that is worrisome. And I would say that is, in fact, unsustainable. Something's got to give. And in my view, that means you need more revenue and you need spending restraint. There's no other way of doing it. And there's some reasonable things that I think we can do. We won't go down that rabbit hole unless you want to, but on both sides of the revenue

and spending. So I think it's not insurmountable. It's doable. It just takes political will. And of course, right now, political will is in short supply in many parts of the world, including in the United States. And, of course, that will really manifest here pretty soon when we start getting around to talking about this debt limit, you know, at some point here in the U.S., we've got to do that

first. But here, I'll end on a more positive note. And that is typically, historically, when the fiscal situation gets to a place where, for example, the interest we're paying on the debt is greater than, let's say, the amount we're spending on the military or some major government support program, people say, that makes no sense whatsoever. How can we be doing that? And that's when you get the, you generate the political will, connects the dots in the people's minds, the electorate's minds and say, hey, this makes no sense. So let's come up with, you know, some common sense compromise solutions around this. And I think we'll get there. So, you know, we had the luxury of a low rate environment, low interest rate environment for quite some time. So the pressure's been

off. And frankly, you can't connect the, even if politicians wanted to do something, they couldn't do it because they couldn't connect the dots between the fiscal situation and the economy for the electorate. You know, you're going to raise my taxes because why? You're going to cut my my social security because why? What are you doing? Why are you doing that? But when you can say, look, if we don't do it, I'm going to be paying more than the Chinese, I'm going to be paying to pay for the salaries of U.S. servicemen and women, they go say, okay, that makes no sense. We're going to solve this problem. So I'm, you know, maybe this is economist to me. I'm a little naive, maybe, but my sense is when push comes to shove, we'll figure it out.

Any risk, Mark, that for countries like Canada, the United States that are facing, you know, high levels of deficit spending, increasing levels of debtedness, that this will play through to rates to future borrowing costs on the part of those sovereigns. I mean, you enjoy the exorbitant privilege of a reserve currency. We don't here in Canada, a small economy, 35 million people. So what in a sense happens to investors, bond investors, who start thinking to themselves, well, there's an inflation risk out there. I'd like a little bit more yield to deal possibly with an inflation premium. And then there are things like your debt ceiling debate. There are seemingly an inability to come up with a fiscal plan that brings debts and deficits and budgets into balance.

Do you start to see that working through in the bond market mark? Or, again, we've just lived through this period of 14 plus years of long-term rates kind of pegged to the floor. And even during this period of hiking rates, we've seen obviously the front end. end of the yield curve explode, as it would, because it's correlated to the Fed funds rate, your overnight rate or the overnight rate here in Canada. But it's at the longer end of the curve, you can still borrow comparatively cheaply, I guess. Considering the world's situation of high inflation, high debt, a lot of geopolitical uncertainty,

explain that to me. Yeah, are you an economist? I mean, you sound like an economist. Amateur economists. No, no, no, you're not playing one. You sound like an economist. I really do. And you make a great point.

You know, one of the ways, kind of the principal way that the fiscal situation, rising deficits in debt hit the economy is through higher interest rates. And this is a corrosive on the economy. It's not like a cliff event. You know, it's like it's not going to matter in any given year, maybe even not even a period of a decade. When you look back over a generation, you're going to say, oh, my gosh, you know, you can see it.

the economy is diminished because interest rates are higher. And a good rule of thumb, and this is also based on work I've done and consistent with the work the Congressional Budget Office has done, that for every percentage point increase in the debt to GDP ratio, one percentage point, that will add all else being equal two basis points, 0.002% to 10-year-year-olds. That sounds like a small amount, but take that increase in debt to GDP I mentioned earlier, 20 percentage points, multiply by two basis points, that's 40 basis points, that's 0.4 percentage points. So instead of, let's say, a 10-year treasury yield that's at 3.8 percent, you're 4 or 2. And you go, well, how big a deal is that? Well, that's a deal. Think about if I got to think about if you're trying to buy a home.

What's the difference between a 5.8% fixed mortgage rate, which is kind of where I think mortgage rates will be here in the long run in the U.S. versus, that's a 30-year fixed. I know you've got different kind of mortgage products in Canada, but that's a 30-year fixed rate. or 6.2. For many households, that's a couple hundred bucks a month in mortgage payment. That's a difference between some people becoming a homeowner, some people not becoming a homeowner. And that's just in the next 10 years. Again, the world's not going to stop in 10. You know, you look out further 23, 4 years, it becomes a real significant problem. And then at some point, these increases in interest rates, they're not what economists call linear. It's not, you know, two basis points,

two basis point. It goes two, three, four, five, six, as an investor says, oh, my gosh, you know, these guys are piling on a lot of debt. The interest expense is going to be very high? Can they really, is this sustainable? Are they going to be able to afford to pay me on time? And you could see interest rates rise even more. Of course, that's less of an issue for a country like the United States because, as you pointed out, we are the reserve currency and, you know, we have a lot of resource.

For other countries, you know, that often is what happens. And, you know, they run into big trouble when that does. But even in the United States, I mean, you can conceive of scenarios down the road here a decade two or three if we don't change something where this becomes more of an issue and is a very significant economic problem. But again, I think once lawmakers can point and say, look, this is what's happening. Change happens. I'll give you a concrete example that back in the 90s, early 90s, that was the last time, you know, we had some pretty significant increases in deficits in debt. And the interest expense on that, on that debt started to rise very quickly. And it was

six, seven percent of GDP for context right now. It's only two to three percent of GDP. And that's when Bill Clinton and Treasury Secretary Rubin came together and said, you know, that was the era of the bond vigilantes. Remember, the interest rates would soar when the government came out with its, you know, a budget plan and you saw large deficit debt. And that convinced lawmakers in the electorate, because they could see that if we didn't do something here, you know, we're all, we're not going to be able to buy homes, aren't going to be able to buy cars, businesses aren't going to be able to invest and expand and higher. And, you know, we, we made, they made the changes they needed to and got a little bit lucky with the tech boom and the revenues that generated. But believe it or not,

in the year 2000, we ran, the United States ran a surplus, a government surplus. That's the last time that happened back in F1, Fiscal year 2000. Hey, Monk podcast listeners. I wanted to let you know about our other weekly audio program. It's called Friday Focus. And hey, guess what? It comes out each and every Friday, It's half an hour long, and it provides you with a masterclass on international events, all the big issues and ideas shaping our world. We've got that for you each and every Friday here at the Monk Debates. Simply access via our website, triplew monkdebates.com.

Click on Friday Focus in the top right navigation. You'll get all the details or check out a sample of the program in the same podcast feed as the main monk debates podcast. I hope you'll join us for the next edition of the Friday Focus podcast. Now back to our program. You know, a lot of people are wondering and hypothesizing about the future trajectory

of interest rates. Hey, it affects everything, our credit cards, our car payments, our mortgages. You mentioned something earlier in our interview. I want to go back to about central banks not wanting to get pushed down to the zero bound. So just to explain that to listeners, Central banks, when they can't cut anymore, they have to start finding other ways to stimulate the economy.

Quantitative easing was one of those strategies, buying large numbers of assets, mortgage-backed securities, bonds, reducing borrowing costs that way. What do you think is going to happen here, Mark? Do you think that there's an awareness amongst central banks that they really don't want to redo of QE? they don't want to go back to the model that really define the decade after the great financial crisis, which was a decade of rapidly rising asset prices, growing economic inequality, high levels of indebtedness. And politicians obviously didn't feel a lot of pressure because borrowing costs were so low during that decade to make any meaningful rationalization of budgets and public finance.

If your target is two, two and a half percent inflation, in the real growth of your economy, real GDP, the valuable things we produce is growing at 2%. That's kind of what Canada grows at. That's what the U.S. grows at in the underlying growth. The kind of the overall growth of the economy, the so-called nominal GDP, that's inflation plus real growth, is about four. And that's where interest rates kind of settle in, the 10-year treasury will be around four, which is okay in most environments. But if you go into recession and the Fed is worried about trying to get the economy back to light by lowering interest rates, you know, very quickly you can see that they have to lower the rate to get to zero. They come to the so-called zero lower

bound. And then they have a choice. Some economies like the Japanese and the Europeans, the ECB, the European Central Bank, they actually went to Swiss, the Swiss National Bank, they went negative. And we could talk about that, but believe it or not, they went negative. I mean, just to explain to people what that is, because it's quite bizarre. Yeah. Well, you as the investor have to pay the government to own the bond. I mean, you're saying, well, why, what in the world? What, what, what's going on there? But, you know, the investor's saying, I don't have any better choice.

I don't have better options. I'm going to do it. But that's weird. And, you know, it has its own kind of negative side effects. Like, you know, the banking system kind of throws up on that, right? Because they're losing money hand over fist. So I don't, in the U.S. And Canada, to some degree, we have a shadow banking system.

You know, that's the financial system outside banks, very different than Europeans or the Japanese, where they have these large banks that dominate the system, in that world, negative interest rates are much more complicated, it's much more difficult to, you know, make work. And so the Fed really doesn't want to do that. Bank of Canada really doesn't want to do that. So then they say, okay, what else can I do? Then they say start buying long-term bonds to bring down long-term interest rates. That's the QE, you mentioned, the civil call quantitative using.

And that's kind of unsatisfying as well. It's not clear how effective that is and how it distorts things and, you know, impacts. you mentioned, income and wealth distribution. So much preferable if they could, you know, we're going back to, you know, raising the inflation target. So the underlying growth rate in the economy, the nominal growth in the economy isn't four, let's say it's five or perhaps even six. And then it's much less likely in a recession that federal will have to lower rates and you actually, to a point where you actually get to that zero lower balance. So that's kind of the thinking around why you might want to raise that, you know, that inflation target going forward. Again, I think the probabilities of

are less than even, but I wouldn't roll it out. It's a possibility. So, Mark, all these central banks now have the luxury of potentially a lot of room to cut into, right? They've raised their overnight rates up into the four. Maybe they'll get into the low 5% range. So that's a ton of potential rate cuts in the future if there was a slowdown in the economy. How do you think that plays out? Is this time different?

Do they, again, do they kind of think to themselves, well, maybe I'm not going to be as quick with the cut. Maybe I'm not going to go as deep with the cuts because I know what it's like once you've given them up and you're trapped down at that lower bound rate that then has a series of less good options in front of you. Well, that depends on inflation. If their target still is two to two and a half and they get inflation in, then they're going to have to bring interest rates down. Otherwise, the interest rates are just too high relative, the so-called real interest rates, the interest rate less inflation is just too high. that will weigh on the economy and ultimately, you know, slow the economy down to a point where unemployment's high. It's kind of a weak economic environment that's unnecessary. So if they go down to two, two and a half, they're going to bring down rates to be consistent with that.

In the United States, the thinking is that that interest rate that makes sense in the long run, consistent with two to two and a half percent inflation is a federal fund rate target. That's the interest rate, the Fed controls, of two and a half percent. So we're now just south of five. You know, we were at zero, you know, back a little over a year ago during the pandemic. They've raised rates very aggressively, the Fed. Now we're at just south of five. My sense is they'll keep the rates there for a while until it's clear inflation is going back to target.

If the targeted is two, two and a half, and again, I think that's the most likely scenario. Then they'll bring the funds rate back down. They'll cut it in half over a period of a couple of years. So by mid-decade, if everything sticks to my script gracefully to, script, you know, the federal funds rate will be back down to about two and a half percent. That'd be my sense of things. What risk or chance, Mark, do you put on the potential that inflation will reset because, again, of just a different world, a post-COVID world, of increasing geopolitical competition,

of supply chains being permanently rewired, less efficient, less just on time? Do you think it's possible that we move into a world? of higher inflation, regardless of what central banks might want, they can't make more oil. They can't build supply chains. There are a lot of things monetary policy can do, but a lot of things that can't also. Is that a tail risk? Is that a low risk? Or is it something you'd put more weight or emphasis on as a kind of known unknown?

It's a risk. I would say it's tail. It's more palpable. In fact, there's a lot of, you know, very smart investors who think that's, in fact, what's going to happen, that inflation is going to remain elevated, very difficult for the Fed and other central banks to get it back to that 2% target. You mentioned a couple of the broader forces at work here that might cause higher inflation's long run.

So de-globalization. So we know that globalization between when China kind of entered on the scene, most notably when they entered into the WTO back in the early 2000s, and through the following 20 years up until President Trump in the trade wars with China, we were globalizing. And that globalization lowered costs and the costs of goods that Americans and Canadians bought actually declined for most of that period because we were buying cheaper goods. It was cheaper to produce in China and Southeast Asia than it was in other parts of the world or in our own economies at the time. Obviously, that's changed. Because of the pandemic and supply chain issues, because of the tensions that now exist

between the U.S., Canada and China, there's no going back here, I suspect, and we're moving apart from each other, which means that it's going to be more costly to produce a lot of goods, and that will put upward pressure on inflation here. There's other broader forces at work as well. You know, the transition costs related to climate change. I mean, we need to do it, you know, but it's not without a cost, and that adds to the cost of doing business and probably adds to inflation. Demographics. You know, I'm a boomer. I represent the largest, well, now my boomers are dying, so I'm not the largest anymore. The millennial generations, but there's a lot of boomers out there that are now retiring, and the living market's tight, really tight, everywhere, tight,

you know, and, you know, immigration is one reason that is really forestalling even more tightness in the United States. And Canada has the best immigration policy on the plan. And it's still, the labor market is there excruciating. I've got a lot of clients in Canada, all they talk about is finding, you know, qualified workers and retaining workers. So if that's the case, then labor costs will be under pressure. So you can make a pretty strong, you know, coherent argument that inflationary pressures are going to be significant going forward.

That inflate, you know, before the pandemic, after the financial crisis, the problem was low inflation below target. The Fed and other central banks were working really hard to get inflation up. And now we're on the flip side. And going forward, it's going to be the opposite. And the feds and other central banks are going to be fighting to get inflation back down. But let me just say this. The Fed and Central Banks will ultimately win the day. If they want to get inflation in, they know how to do that. And they will do it. So if they're going for two, two and a half percent, they're going to get there. They may need a higher rate. Maybe that two and a half percent rate I mentioned earlier is not high enough. It might have to be two and three quarters. It might be three. There's a lot of debate about that. There's, there's no. no Rosetta Stone that says, you know, it's two and a half percent and it changes over time. So that may have to be higher, but at the end of the day, central banks are going to get what they want. You know, maybe not in any given year, but over a period of time, they'll get inflation into their target. Mark, if we did contemplate a world where overnight rates had to be higher to deal with these kind of structural embedded inflationary forces that we may live with now for a period of time, what does that do to everything?

else. What does that do to a world that's just so indebted? If you look at these, not just the United States, but globally, the degree to which corporations, governments, individuals, we have gone on just an incredible debt binge over the last 15 years, but let's face it, it's been a longer trend than that. How does a global economy work when the cost of capital goes up and yields are higher? And yes, that's great for potentially for investment, but for debtors, that requires a payment of a stream, you know, for whatever duration that debt is held for. How do you think that plays out? Are we able to sustain those higher interest costs based on just how the economy at a global macro level has changed over the last period of time? Yeah, good point. I would point out, though,

We're talking about rates that are maybe a quarter percentage point higher or half a percentage point higher, not three percentage points higher. So, you know, it's a smaller, I don't think it's going to take, you know, massive increases in interest rates, you know, for the Federal Reserve and other central banks to get inflation, you know, down to where they need to get it. Obviously, a lot of uncertainty and risk around that, but that would be my sense of it. But having said that, regardless, as you point out, there is a significant increase in leverage debt across the globe in the previous world we were in when inflation was low and interest rates

were low. Because when interest rates were low, you can borrow and your interest payments remain low, your debt service remains low, no big deal, no problem. You can afford it. But in a world of high interest rates and you still have that debt, you haven't paid it off, your interest payments are going to be higher. It's going to be much more difficult. And this goes back in the United States, the kind of the default line here is the federal government. That's where the debt accumulation has been most significant. That goes back to the interest expense. of the federal government I was talking about earlier. Household leverage is low here in the United States.

It's not as big a deal. We de-levered after the financial crisis. Forced de-leveraging because of all the foreclosures and all the busted mortgages. And since then, all the lending has been fixed mortgage lending, which is the bulk of the lending, is long-term fixed rate, 30-year, 15-year rate. And people have locked in record low interest rates. So they're pretty insulated. Yeah, and just to give people a flavor.

or the contrast to Canada here, we, you know, our longest mortgage is five years, many people on variable not fixed rates, and we have, you know, debt to income ratios north of 165 percent, because we didn't de-leverage after the GFC, which I think, again, many Canadians, we understandably applauded our banking sector and the strength of the sector, but when it came to housing, our single largest asset, there was no significant price correction. And then we went through another 15 years of record price gains. Yeah, exactly. So household leverage in Canada is very different than in the United States.

We kind of went on two different trajectories after the financial crisis. And leverage, household leverage in Canada kept rising. And it continued to decline quite noticeably in the U.S. So that's a big difference. And you're right. Your mortgage products are very, very different than they are here in the U.S. So I think there's more risk in, particularly in the household, among households in Canada, than they're in the U.S.

In terms of businesses, businesses also have done a pretty good job. They're in terms of managing their debt and leverage, the distribution of the debt across businesses is kind of bimodal. You know, you've got a boatload of companies that have very little debt leverage. You know, think Amazon. Or I don't know about Amazon, but think Google. You know, they got cash everywhere. They may, they probably have, they probably have debt, but only because it was free.

You know, they could borrow it, you know, quarter point for a hundred point. hundred years or something. So they said, well, why wouldn't I do that? It's free money. But on the other end of the distribution, you've got levered up companies, mostly mid-sized companies, where leverage is a lot higher, and that will be more of an issue. But in aggregate, the corporate sector, the business sector is okay. And pretty good ship, I think it can manage through. So in the United States, the problem is in the federal government. That's sort of the debt's a problem, not among households and to a lesser degree businesses. In Canada, it's really in the household sector where you've got the most leverage. But in other parts of

the world, it varies. And leverage is a problem. You know, even in, you saw in China, for example, their real estate sector is where the leverage is a real problem. They're struggling with that right now. But you make a great point in the future, if rates are higher, that is going to put pressure on folks that are levered up. And, you know, we'll, you'll see. see credit problems and other issues because of that. It's going to be an adjustment. Just two final thoughts to end on as we wrap up this fascinating interview, Mark. You know, after the Second World War, part of the response of governments to record high levels of indebtedness was something called yield curve control. They, in a sense, pegged yields,

especially long-term yields to ensure that... They're not an economy. Come on. How many people know that? I mean, come on. I'm fascinated with yield curve control. because the Japanese have been engaging. Okay, you're very weird. If you're not an economist, you're very weird. I'm just saying. Go ahead.

In more ways than what. In Japan, we have now this multi-decade experience in kind of Yolker control. Mark, is this, is financial repression more likely part of our future as it was trying to understand historical analogous periods in that Second World War period where the world. came out of a crisis, high levels of debt, and yield curve control was the preferred strategy to exit that phase. Yeah, I don't think so. I mean, you point to Japan.

I mean, Japan's got it's very idiosyncratic, right? I mean, that economy is very insular. It's kind of a bimodal in terms of its exposure to the rest of the world. You've got some large businesses corporations, you know, like a Honda or Toyota that are very globally oriented. The rest of the economy is very insular. There isn't a whole lot of competition. It's very ossified, not a lot of innovation, not a lot of change. Wage growth is very depressed.

And then, of course, they don't – Japan is very restrictive when it comes to immigration flows. Very difficult to get participation rates up, female participation rates up. So it's a very – just a different kind of culture and economy. Most of the debt, I believe, is held domestically. Yeah. The central bank owns a lot of the debt. But so it's just a weird kind of a weird economy. It's not, you know, in many respects, very, very different from the Canadian and U.S.

economy. So I don't think I look there as an example where the U.S. and Canada are headed. I think it is really key, though, for the U.S. and Canada to hang on to what makes our economies really dynamic and tick. And that is free and open borders. You know, we need immigrants, you know, skilled, low skilled, you know, all of all. the above. We really need our small businesses, you know, that are startups that create, that are innovative and take risks. And, you know, they're the vanguards of innovation and productivity

growth. And, you know, I think our economies are, you know, very good at that. And kind of a more liberal society when it comes to participation by all kinds of groups in the labor market, those kinds of things. You have to fight for those things. You know, there's a lot of political cross currents, particularly in the United States, with regard to many of those things. But I think as long as we are able to hang on to them, we're going to be a very different kind of economy. And I don't think we'll get into a situation, kind of the stagflation, stagnation, not even stagflation, stagnation, kind of economy that has plagued a place like Japan. Great insights. Finally, you know, we saw this big bank bailout in the United States, Silicon Valley Bank,

probably some of the wealthiest depositors, most financially sophisticated depositors in the world, certainly in the United States. When that bailout came, all those depositors made whole 100% on the dollar. And there are lots of arguments why maybe that was the right thing to do in the moment. Other people, though, hypothesizing that, again, another example of the kind of moral hazard going away. And if you maybe pull the camera back, you could, Mark, potentially look at the last decade, and a half as a series of incidents where there were or was bad behavior in financial markets primarily. And that behavior, many of those costs were kind of socialized, socialized through central bank balance seats, socialized through taxpayers and federal government deficit

spending to bail out actors, bad actors in the financial system. A, are you concerned about the state of moral housing? Is it a concept that still exists? Is the financial system and market just so inherently complex and potentially fragile that maybe that's something we relegate to the past? And we're in a different financial world, a world where bailouts, bail-ins, active central banks with trillions of their balance sheets will be part of our future, whether we think it's a good idea or not. Yeah, this is a tough one. I can see both sides of this argument, although in this very specific case that were Silicon Valley Bank and, of course, signature bank, the other crypto bank that went under at the same time, I don't think policymakers, the Treasury, the FDIC, the Federal Reserve had any choice here because there was massive deposit outflow. People were spooked. My grand, my 93-year-old mother-in-law was asking me, was her CD safe? And, you know, it's like 50K sitting in a major regional bank. Like, okay, you know, if it gets to the level of my 93-year-old mother-in-law asking me that question, that's a problem.

You know, that means people are really nervous. And I don't think you have a choice. You know, and there's no delay here. You know, if you delay even a little bit or waver a little bit, you got a bank run. And once you got a bank run, you could putting that genie back in the bottle really hard to do. So I think it's clear that policymakers have come under a lot of criticism for doing what they did. but I would suspect that anyone else who was in their position would have done exactly what they did. They had like zero, no choice.

Having said that, you know, it does lead to, well, you did bail out these depositors. And in a sense, the bank itself is not going to be disciplined by this. But, you know, I'd say a couple things. One, it's not like shareholders didn't get nailed. You know, they got creamed. They're wiped out. I'm pretty sure the bondholders in these banks, if they get any cents on the dollar back, it's going to be one, two, or three pennies.

I don't think they felt like they got bailed out. The senior management of these companies, they're getting pilloried, you know, in the public square. I'm sure they're feeling like they're not getting bailed out. So I don't know. It feels like there's going to be a fair amount of discipline with regard to, you know, the stakeholders. Maybe not the depositors, but I'm not sure that you could never really count on the depositors for doing much policing here. Here's the other thing I'd say, though.

And that is it does argue for regulation. So one reason why SBB and got into the mess they did is because of the rollback of some of the regulations that were put into place after the financial crisis, so-called Dodd-Frank. Higher levels of capital, that's the cushioned banks have to digest the losses. They suffer more liquidity. That's the cash they need to pay off their funds. funding needs like depositors, stress testing, that is simulating the impact on the balance sheet income statement of the bank of different dark scenarios. And SVB did not have to engage in many of those more stricter requirements because of a

rollback in the Dodd-Fank legislation under President Trump in 2018. That was a mistake. And I think, you know, the Fed has said it's a mistake. You saw that in some testimony this week in front of Congress, the Vice Chair of Regulation at the Fed. Michael Barr said, we're going to change that. And I think they will. So I think that's going to go a long way to addressing this issue. If you can't design incentives to get the private sector to oppose the necessary discipline on banks' behavior, the next thing you do is you say, okay, you got to hold more capital. You got to be more liquid.

You got to tell me that you can withstand a 10% unemployment rate and interest rates that are going up 500 basis points, five percentage point. So I think that's the strategy that we'll be taken here. But it's a difficult one. It's a difficult problem. The other thing I'll just throw it out into the mix. in thinking about this, is we may live in a being living in a different world, a world of social media, where bank runs become more likely, right? One of the reasons why SBB had such a terrible bank run is because you had some folks out there tweeting, get the heck out, and some people with very respected voices in social media is saying that. And I suspect that, you know, caused the herd to leave. And so that change in the way we live, you know, the social world of social media,

may in fact change the way we have to think about bank runs and how to stop bank runs. What do you think this does for international perceptions of the United States? You know, the U.S., and look here in Canada, we're counting on you in no small part to kind of defend a liberal international world order against competitors like China and Russia. Yet here in a sense, while it's not a major financial crisis like the great financial crisis, you know, here's yet another American made-in-America mess up of not insignificant scale and size. These things don't seem to happen in Europe. I mean, they do occasionally, but they don't. Yeah. Well, but some people wonder, though, was the Credit Suisse tip-over triggered by SVB to a certain extent, right?

Would that have happened without SVB doing what it did? In fact, was that an example of some contagion, you know, jumping across the pond? I'm just wondering if there's a concern here, Mark, about, you know, American global financial prestige. We're seeing news recently that China and Brazil have entered into agreement to settle trade in Juan. We have Russia and China engaging in petroleum sales and Juan, Saudi Arabia, talking about Juan increasingly the Chinese currency as a unit of exchange. I know these are big questions, but I think they just go to this idea that the world order that we depend on on large part is an American-led order.

And it's an American-led order not simply because of your military and diplomatic prowess. it's because we live in a U.S. dominated global financial system. And are we starting to see post-COVID the signs of that system coming under real stress as players peel off in the face of the threat of sanctions, of the confiscation of, you know, currency reserves, of, you know, American seeming problems with financial management within their own borders and over their own institutions? I don't think so. I mean, it's messy. The U.S. economy, political, kind of backdrop.

Debt and deficits, which you've talked about. Yeah. You know, we're a messy place. There's no doubt about it. And we, you know, we take risks. Things are always moving, changing pretty fast. And businesses are always thinking, how do I get out of the shackles? So, you know, the regulation and rules and everything else that are keeping me from making more money and innovating and changing and doing the things I want to do. So it's, you know, that leads to periods like these when things aren't, they go off the rails. They go off the rails. And it's just a kind of, you know, a symptom or irregularity of the kind of the American system. So that's the downside.

But the upside of that is you get innovation, you get change, you get new ways of doing things. you get stronger productivity growth. You get, you know, the more dynamic kind of economy that kind of leads the way. And I think that ultimately, and people want to be here because you can do those things. You know, you're not shackled. You're able to do it. You're not nailed down to a post. So, you know, people fail.

If you don't fail, you can't succeed. That's kind of, you know, it drives the train here. You know, that in every respect. You know, we, lots of foreclosure. lots of bankruptcies. But that's, you know, sign, and in fact, in some spheres, that's viewed, bankruptcy is viewed as a, you know, that's a good thing. You know, if you're not, if you haven't gone bankrupt once or twice, that means you're

not trying hard enough. You're not taking enough risk. So it's just a different culture, different perspective. And, you know, I think, you know, the thing that will always preserve, at least, you know, in my lifetime, and probably my kid's lifetime, the U.S. is kind of the place where people want to be is because you have a rule of law. I mean, we fight over it. We debate it, you know, but at the end of the day, if you have an argument with somebody, you can get it adjudicated and you can feel pretty safe that it's, you know, you're going to get a, you know, fair shake at, you know,

that adjudication process. So, and it's free and open. As free as open as it can possibly be. So I think that means the best in the brightest ultimately want to be here. Well, Mark, thank you so much for your time today. A fascinating, far-reaching conversation. followed your work closely for a long time. You're a terrific communicator taking these complex ideas and theories and bringing them down to something I consider pretty damn close to common sense. So thanks, Mark, so much for coming on the Monk Dialogues today. My pleasure. Thanks for having me. I appreciate that.

Well, that wraps up today's Monk Dialogue. I want to thank our guest, Mark Zandi, of Moody's Analytics. Check out Mark Online. He's got his own podcast. well worth a listen. Also, if you have feedback or reflections on what you've just heard, please send us an email to podcast at monkdebates.com. That's MUNK DebateswithanS.com. And just a friendly reminder that on this same podcast feed,

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