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The main question for the economy is whether or not we can see a big drop in inflation without a major recession or increase in the unemployment rate. On this episode of the podcast, we speak with Goldman Sachs Chief Economist Jan Hatzius, who thinks it’s a longshot, and that it will be difficult to avoid a hard landing. The transcript has been lightly edited for clarity.
Points of interest in the pod:
The narrow path to a soft landing (4:44)
When will the Fed declare victory (8:50)
Why inflation got this high (10:58)
The quality of job openings data (17:42)
What would constitute a full-blown recession? (22:22)
What’s happening with inflation expectations (29:14)
The international inflation situation (32:16)
The trajectory of rent inflation (36:00)
What tight commodity markets mean for growth (42:08)
What to watch at Jackson Hole (51:02)
Joe Weisenthal: (00:00)
Hello, and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway: (00:06)
And I'm Tracy Alloway.
Joe: (00:07)
Tracy, I feel like the big question right now from a macro perspective is "Can we get inflation down to a level that's consistent with the Fed’s target around 2%, or at least trending in that direction, without a painful recession or a significant rise in the unemployment rate?”
Tracy: (00:26)
I think that's exactly right. So this is the whole soft landing issue. Can the Fed hit the brakes on rising prices without pushing the US into a recession that pushes up the unemployment rate? And I have to say history is not really on their side. We do not have a lot of successful examples of the Fed being able to do exactly that.
Although at the moment, if you look at market pricing, we're recording this on August 2nd, you know, if you look at market inflation expectations, they do see inflation going down. There is obviously some concern about recession risk, but I don't think we're yet at the point where people are pricing that as inevitable. So despite the lack of successful historic examples of the Fed actually engineering a soft landing, it feels like a lot of the market thinks they're gonna manage to do it this time.
Joe: (01:21)
Well, you know, you mentioned history and yes, I think history is not too kind. And I think many people would say, “Look, when inflation is this high historically, or when inflation is significantly elevated, you get the only way to bring it down is with a tough recession.” On the flip side, maybe there's no reason we should be looking at history is the thing I keep coming back to...
Tracy: (01:42)
This time is different. Are you gonna say it, say it Joe, say “this time is different.”
Joe: (01:47)
I'll say this time could be different. And the reason I say that is not because, I’m naïve or pollyanna-ish, but this has been an unprecedented two years. We had a pandemic. It was a matter of policy to bring the economy more or less to a halt alongside massive fiscal stimulus. We still have a pandemic. We have the shift from services to goods consumption. So there's nothing like that we've ever really seen. At some point, we're gonna see this renormalization, which is already happening. And so like, it seems very plausible to me, that history as a guide is just not a useful roadmap for the situation we're in right now. And maybe that's good news, but I wouldn't bet on that. I just think it's possible that history is not so useful here.
Tracy: (02:31)
I think that's a fair point, but you could also say that economic exceptionalism or, you know, thinking that our current economic cycle is somehow unique or exceptional in a way helped to get us in the place where we are in right now, where inflation has come in and has stayed much hotter than expected.
Joe: (02:52)
Right, the failure of the Fed's transitory messaging starting in Summer of 2021 really is kind of probably why a lot of people who maybe thought like me, “Yeah, you know, there are a bunch of disruptions, they're one-offs and then the one-offs are gonna fade.” And all the weird price shocks are gonna fade too. But anyway, the stakes have gotten high because since then inflation has gotten only higher and higher. Many false hopes that it was gonna turn down. And just now the question is how much more will the Fed do and how much pain will we see, cuz the Fed will, you know, the Fed is determined it seems to get that inflation rate down. How much pain do we have to bear for that to happen?
Tracy: (03:33)
Yeah. It's kind of funny. I was thinking about this the other day, but it's kind of funny that in order to make things affordable in general or things more affordable in general, some people have to like lose their income altogether…
Joe: (03:48)
It's perverse! Anyway, let's dive in with someone who knows way more about this than either of us. We've had him on the podcast a few times, several times over the years, I'm thrilled to have in studio, I'm in studio. Our guest is in studio. Tracy is on the line sadly, sadly missing, missing this in person. Anyway in studio it’s Jan Hatzius, the chief economist at Goldman Sachs. So Jan, thank you so much for coming back on the show.
Jan Hatzius (04:17)
It's so great to be with you Joe and Tracy. Really wonderful to have the time to explore some of these issues. They're obviously extremely central to everything that we're thinking about.
Joe: (04:27)
We got plenty of time, so let's try to learn something. So let me just ask you the multi-trillion dollar question, which is, can we see inflation get back to, if not 2%, at least something in that vicinity without incurring a painful recession in the us?
Jan: (04:44)
I think it's possible. And I do think that there is a path towards, you know, something like 2% that doesn't involve a recession, but it's a very narrow path. And obviously we've seen a lot of unanticipated shocks over the last two and a half years. So you have to be very humble, I think in your ability to predict what's going to happen.
You know, I'd say the first part of the inflation slowdown, you know, several percentage points maybe, you know, right now we're a little over 9%. If you take the headline CPI. We're a little below 5% if you take the core PCE, you know, getting back down to the sort of 4% range or so I think is going to be relatively easy because I do think that will be lapping a significant amount of weakness or significant increases in commodity prices.
I also think that if you look at the goods market, you know, supplier deliveries, indices, and other measures of supply chain issues, those have improved pretty rapidly. I mean, you look at business services, there's really been an impressive amount of improvement just in the last few months. So I think that part is not going to be too difficult.
The harder part I think is to then get back down from 4% to something in the vicinity of 2%. And I think for that, we do need a labor market adjustment. The labor market continues to be very overheated. We still have, you know, close to 11 million open positions and, you know, less than 6 million unemployed workers. That's still a very large gap, basically unprecedented, both in absolute terms and relative to the size of the population in post-war history.
And, you know, I think that is the imbalance that the Fed is going to have to address and the way they want to address it, of course, is by bringing down open positions without raising unemployment too much. If you see a large wave in layoffs then that's likely to mean a recession. In fact, you could say that is a recession. And that's the goal, you know, I would say on the slightly encouraging side so far in, you know, over the last three months, we've actually seen a fairly sizable adjustment in open positions. They're down more than a million and, you know, so far without an increase in the unemployment rate. So I think the path that they're trying to stay on here is growth below trend with a decline in labor demand and therefore an unwinding of that imbalance that ultimately brings down wage growth. And that allows us to get back to something in the vicinity of 2%. You know, it's a tall order for sure, but I am, I would say, somewhat encouraged by what I've seen over the last several months.
Tracy: (08:12)
You know, you mentioned getting inflation back down to 4%. I wonder, is there a chance that maybe the Fed would be satisfied with 4% and maybe in a new normal of strained commodities supply and energy crises in Europe and things like that, maybe the 2% target, I don't wanna say it gets abandoned, but maybe the Fed is willing to stomach slightly higher inflation at 4% without having to tip the entire economy over into recession and really seeing unemployment go up?
Jan: (08:50)
I think 4% is more than slightly higher inflation. I don't think 4% would be remotely acceptable from the Fed's perspective. You know, a 2-handle, I think maybe that that may be okay. 2.5%, you know, in a still fairly strong labor market environment, I think would be, would be fine from their perspective because if you had 2.5% in a strong labor market, then, you know, from an average inflation target perspective, you'd be expecting the economy to go into a recession at some point that probably would bring inflation down to less than 2%. So, you know, I think that could be consistent with a 2% average inflation target. Maybe you could push that a little bit more to two and three quarters. I think a three handle and certainly a four handle would be too high from their perspective.
And I think if you listen to what Fed officials have been saying over the last several months, I mean, it's pretty striking that they really haven't deviated from saying, “We want to get back to 2%” and you know, in part, I think that's because inflation is very unpopular. I mean, one of the things we've discovered or maybe rediscovered is that, you know, people really don't like inflation. So I think there's not much mileage in saying, “Oh yeah, maybe 3% or even something more is okay” because I don't think that's how people think about it.
Joe: (10:20)
So to think about what might cause the inflation rate to fall, or how far it can fall, it might be helpful to decompose the drivers of the upward move, which has consistently caught everyone by surprise. The Fed’s certainly been caught by surprise. Economists and the market itself have been surprised. In fact, we keep seeing these new highs. How do you think about the different factors between sort of disruptions related to the pandemic, monetary and fiscal expansion in response to the pandemic, and then other idiosyncratic factors, most notably, probably is Russia's invasion of Ukraine. How do you think about weighting some of these factors for how we got here today?
Jan: (10:58)
Well, it depends on which inflation indicator you're looking at. If you take the headline numbers, then of course the sharp increase in commodity prices is a very important part of that.
And some of that is driven by, I think, more structural issues, like under-investment in the commodity industry, which my good colleague Jeff Currie has talked about. I know he's talked about it on your program. But then of course we've also had some additional shocks that also have had an impact, most notably the Russia-Ukraine war.
I think supply disruptions that are related to the pandemic and related to the fact that in the spring of 2021, we thought the pandemic was receding into the background. But then you had Delta and then you had Omicron and then you had Omicron again, and then you have a succession of BA waves.
So yeah, I think that has played a role. I do think that that is abating, at least as far as the supply disruptions are concerned. At least for now. So there are a number of things that are probably somewhat more temporary in nature that I would put into the category of unfortunate and unforeseen shocks.
But then I think the other big issue really is the labor market imbalance. And I would say that a lot of economists, certainly I have changed my thinking about labor market balance. If you had asked me about full employment and how I would define full employment a year and a half ago, I would've given you an answer that was based in part on the unemployment rate and in part on the employment-to-population ratio, but open positions would've been would've had only a supporting role.
And, you know, if you, if you look at unemployment or employment to population a year and a half ago, we were still really far away from the sort of pre-pandemic level. I mean, it was very hard to sort of envisage that we'd be close to full employment even a year down the road. And you know, the truth is employment-to-population is still well below where it was pre-pandemic.
But job openings, I think, are playing a much more central role because they basically give you the balance between total labor demand and total labor supply. And so I've definitely changed my thinking about labor market balance. And the labor market's very overheated.
Tracy: (13:59)
I wanna dig into the labor market a little bit more, but just before we do I feel like when it comes to inflation, we all agree that inflation has been higher than a lot of people initially expected. But it feels like there's less agreement on exactly why. So there's still a lot of focus on one-off factors, like Russia's invasion of Ukraine, but could you maybe just give us a sense of, you know, why has it turned out this way? Why does inflation continue to be higher than expected? And, you know, looking back, I suppose, what, in retrospect, did people miss? Because we still have even people like Chairman Powell saying things like what was that quote? We now understand how little we understand about inflation, and yet we're all focused on it at the moment, but like everyone seems to admit that we're not entirely sure what's driving prices.
Jan: (15:01)
Again, it's a combination of some, you know, unforeseen shocks and, you know, an underestimation of how tight the labor market really was a year and a half ago. I mean, we certainly shared in that. I didn't think that we were anywhere close to full employment. And now I think we're significantly beyond full employment, at least in terms of the balance between a total number of jobs and total number of workers.
And so it's a combination of things that were maybe harder to forecast just because shocks, by definition shocks are shocks and things that, you know, with a better model, we would've anticipated and, you know, that's why we've kind of changed our model, uh, of how to think about this.
Joe: (16:03)
So I'm looking at these two charts now in the terminal, and you have the employment-to-population ratio, which not only is not back to pre-crisis levels,. it's actually turned down in the last few months, which maybe is a little bit of a source of concern. And then there’s the job openings data, which has started to turn down, but that one is sort of way off the charts higher.
One quick question on job openings. Is that high quality data? Like it's not hard to put up a job listing these days. And I forget who it was, but we did speak to someone months ago that questioned this time series. Like is this historically comparable, given the proliferation of job boards and the ease with which one can post?
Tracy: (16:57)
I think there's also a theory out there that some of this was driven by PPP and that if you say that you're still struggling to hire workers, you still get some support from the government. So there's also like a question over where whether those pandemic policies actually have an impact too.
Jan: (17:42)
No economic indicator is perfect, and that's certainly true for the job opening series.
I mean, the official JOLTS series which is published by the Labor Department, I think is higher quality than a lot of the other job boards, which I would use as maybe kind of confirmation of what I see in in the Labor Department numbers. The Labor Department numbers are verified openings. We have not really found a lot of evidence that the meaning of a job opening is dramatically different relative to 10 or 20 years ago. And if you look at the official series as of a year and a half ago, it wasn't out of line with history. And technologically, a year and a half ago wasn't that different from where we are now.
It's it only really moved out of line with history in the summer of 2021. So to me that's somewhat encouraging in terms of the quality of the data, but, you know, I do think you want to verify tightness of the labor market via other indicators. Another indicator you can look at that, I think, is pretty useful is the quit rate. And broadly speaking, the quit rate confirms that we're in a very tight labor market, though one that is loosening at the margin. So we had literally an all-time high in the quit rate, you know, several months ago. And we've come off of that slightly. Haven't seen as much of a downturn as in the job openings numbers, but I would say broadly speaking confirms what you see in the job openings data. It’s a very tight labor market.
Joe: (19:31)
So going back to the employment-to-population ratio, or some of these other measures, they have topped out. They never even got back to pre-crisis levels and they may be flatlining or even turning down. What do you attribute that to? What's like the big change in the composition or the size of the labor market? Because that seems to be at least one factor contributing to this big supply/demand mismatch in labor.
Jan: (19:59)
So I'd say looking at the Household Survey of employment in general, you know, it's been significantly weaker than the Establishment Survey over the last several months. So I would probably take the downturn that we've seen in the employment to population ratio, which of course is based on household employment, I would take that with a little bit of a grain of salt. I don't know that we really have a lot of evidence that it's turned down. I take more of an average between the Establishment Survey and the Household Survey, which would say definitely slower employment growth, but probably not an outright decline. With that out of the way, I do think that the employment to population ratio probably will be lower at whatever the peak of this cycle is than it was in the previous cycle, because I think aging of the population of course has continued.
So that is a kind of structural driver of declines in employment-to-population. And then in addition, we've seen some people withdraw from the workforce. We've seen significant amounts of early retirement and I don't think that that's really going to reverse either. Over the very long term, the impact should decline, but it's not going to reverse quickly I suspect.
And so then, then I think a last point and this is related to it. I don't think it's visible of course in the employment population ratio is that we had very few immigrants for a year or two, and that, unless we see kind of catch up immigration immigration flows that are actually larger than the pre pandemic rate to make up for that, we're also going to have a permanently smaller workforce than we would've otherwise otherwise had. Again, that's not for employment-population, but it's important for the overall number of workers.
Tracy: (22:04)
So how much can unemployment actually rise without tipping the US into a full blown recession? And then secondly, when you look at something like JOLTS falling, and we just had the JOLT numbers come out today, we're recording this on August 2nd, you know, we saw a higher than expected drop in job openings. How concerning is something like that to you given your new framework?
Jan: (22:33)
So a decline in job openings is not concerning. In fact my view, it's a good thing because we need a rebalancing of the labor market and it's much, much better to have that rebalancing of the labor market via declines in job openings rather than an increase in unemployment.
And you know, if firms get rid of job openings that does not have negative second round effects, you're not cutting anybody's income by removing job openings. Increases in the unemployment rate and layoffs are a very different story. You do cut people's income. You impose hardship at the individual level, and you're also taking income out of the economy. So you're weakening the cycle. History would say that you can only see a small increase in the unemployment rate without going into recession. At least in US history, we've never seen an increase in the three-month average of the unemployment rate of more than 35 basis points without a recession.
If you look outside the US, you know, that looks a little bit different. So I certainly wouldn't view it as law of nature, but I think it does drive home that sizeable increases in the unemployment rate have historically been associated with recessions and probably in part, because, through kind of causal forces that you've seen, you know, declines in disposable income on the back of layoffs, which have then fed into weakness in spending. Historically, I think that's often been a factor. You know, I think we might be in a somewhat different situation because weakness and disposable income. Yeah. At least in, uh, in 2022, you know, it's driven by inflation and fiscal tightening as opposed to labor market forces. So, you know it may not quite the same may not be quite the same situation as over the entire stretch of history. But it's definitely something to watch
Joe: (24:52)
If the labor market is so tight, why have we seen negative real wage growth?
Jan: (24:58)
I think because, you know, wage decisions are really more around nominal wages than around real wages. So I do think what we've seen in wages has been quite consistent with an overheated labor market. I'd focus on the fact that, you know, most wage indicators are showing something like five and a half percent year-on-year growth. And that's very high — way higher than what's consistent with a 2% inflation rate.
Joe: (26:19)
Let me ask you, you know, Tracy mentioned like, “Okay, at what point does an increase in the unemployment rate, constitute a recession.” And basically if it starts ticking up, there's a good chance we're gonna get a recession. At what point does the Fed seriously have a problem on its hands about the correct course of policy, if unemployment were to start ticking up, but inflation falls much slower than hoped. Walk us through how you're thinking about that risk. Like the real stagflation risk that's out there.
Jan: (26:57)
I think it depends on what you see in other indicators. You wouldn't just want to focus on the realized inflation numbers because that is, you know, going to be pretty backward looking. I think you want to look at overall measures of supply versus demand in the labor market. You want to look at the wage numbers.
I mean, it certainly could be that you'd be in a difficult situation because, while you do want to focus on forecasts, forecasting is always difficult and it's probably more difficult in the current environment than it has been in previous cycles. So I think there is a real risk that if you did see a sharper downturn, that it would be difficult to know exactly at what point you should reverse course on monetary policy, you know, with that said, if I focus on the last FOMC meeting, I think there was some reassurance from Chair Powell, as far as markets were concerned that, you know, he said, we are going to look at both sides of this.
I don't think it was a particularly dovish meeting, to the degree that perhaps he might gauge from where market pricing has gone, but it was reassuring in the sense that he certainly didn't say we're only focused on inflation.
Tracy: (28:29)
You know, Joe asked you that question about if the job market is so tight, why haven't wages gone up more? And this is I guess one of the few good things that we have going at the moment, which is that inflation expectations so far seem to be reasonably well anchored. You know, unfortunately a lot of people don't think they're gonna get, uh, massive pay increases. And a lot of people, at least according to the survey measures, still think of inflation as transitory. How much does that help the Fed? And is there a risk that at some point those expectations become unmoored?
Jan: (29:14)
I think it's hugely helpful. Certainly if you compare it with the alternative. If inflation expectations were anywhere close to current actual inflation, headline and even core, I think it would be much harder to have any realistic scenario of bringing inflation down without a very significant amount of economic pain.
I mean, if I look at the, the kind of economic history of the late 1970s, early 1980s, inflation expectations based on the indicators we have become, you know, very significantly unanchored on the back of repeated increases and, and ongoing trend increases in inflation over the previous 15 years. And it turned out to be extremely painful to bring inflation back down to the kind of 2% to 3% range in the subsequent decade.
So I think most of the long term inflation indicators, inflation expectations are still consistent with something like 2%. We’re in a much, much better position. And I'd say it's one of the real significant upside surprises that we've seen over the last year and a half. If you had given me all of the inflation related indicators, other than the expectations measures a year ago, and had asked me to predict where the expectations measures, I would've given you a much higher number.
Yeah. And that also, I think is important for the second part of your question, because, you know, while of course we need to watch whether this anchored environment changes. I guess I'd be surprised if we had a major change having watched what these indicators have shown. You don't want to overstress your luck in this. You do need to watch it, but I would expect inflation expectations to stay anchored.
Joe: (31:25)
So here's a question that I can pose to you because you're a Goldman's chief economist for the whole globe. You know, inflation isn't just high in the US. Throw a dart at the map, and there's a good chance you're gonna hit a country where inflation is at like 40-year highs. And there are different factors, you know, in Germany, obviously, headline inflation is very exposed to electricity prices and the increase in the cost of gas, but it's not just Germany. And it's not just headline. And core in Europe, in the euro area, continues to march higher. We haven't seen that turn down either. And in Europe, you can’t blame the extra $1,400 checks or anything like that. Does looking at inflation on a global basis, can it be used to inform anything about root causes and the drivers of it?
Jan: (32:16)
I think so. I think it does show that common shocks as opposed to country-specific policy choices played a very important role in this. But I also think that you see some evidence of country-specific developments. So if you take the euro area versus the US, you know, certainly both headline and core inflation have converged to some degree. But on the labor market side, you know, I think we still have a pretty significant difference. Wage growth is accelerating in Europe, but, it's moving to 3%, whereas in the US it's moved to 5.5%. And, you know, 3% is still, that's still relatively well behaved. It's I think it's much harder to argue that the European labor market in aggregate is overheated.
So I think there still are some differences. With that said, I think those differences don't look quite as stark as they did, maybe six months ago or 12 months ago. And, you know, not only because of additional shocks because I think we've probably learned a little more about what's happened to core inflation, not just oil and natural gas prices.
Tracy: (33:42)
So Joe asked the global question on inflation, and I'm gonna go right back to asking a very granular US inflation question. But can you talk to us about rental inflation? Because there has been some concern about rents going up and people are sort of wondering when and where that might stop. And also people asking questions about how higher rents interact with the housing market as well. So, you know, at what point does it maybe make more sense to buy a house versus renting if everything is going up? I'm just wondering how, how you're sort of thinking about that.
Jan: (34:29)
Rental inflation certainly has been an ongoing upside surprise. I would say in the last few months, it’s actually been the most important upside surprise. More important, I think, than the commodity numbers, because we sort of know where those are coming from.
You know, both rent and Owner's Equivalent Rent have continued to accelerate and the last couple of numbers are in the sort of 8% annualized range. I think there is good reason to believe that we'll see lower rent inflation as we go into 2023. If we look at some of the more bottom-up indicators, rents on new leases, those have decelerated. The housing market, more broadly, clearly is decelerating. The labor market is decelerating. I mean, statistically, that is an important driver of rent inflation. So I think by 2023, I would be reasonably confident that we'll see a deceleration, but over the next few months, I think it's a major upside risk to the inflation numbers. And we actually just pushed up our core PCE forecast, you know, somewhat further because rent has continued to come in.
Joe: (36:01)
Where do you have core PCE going to?
Jan: (36:02)
We have it at 4.5% percent by the end of the year.
Joe: (36:07)
We're at 4.8% right now. So not much progress from here...
Jan: (36:12)
There are a number of factors going into that, but an an important factor is the rent situation.
Joe: (36:28)
Can you describe just sort of what your current short and medium term outlook for both, I guess for both inflation, but also for the Fed policy is? How many more hikes through this year, and then what beyond after this year?
Jan: (36:41)
So for inflation we have, core inflation coming down, you know, very modestly through the end of the year, and then more significantly in 2023. That's also partly related to rent. So we have core PCE at 2.5% by the end of 2023, that's a pretty significant deceleration. Obviously, still somewhat above the 2%, but probably more consistent with where they would be comfortable at least in a continued expansion.
And then on Fed policy, you know, we're expecting a 50 basis point move at the September meeting. So ratcheting down the pace. And then we have two more 25 basis point moves in November and December which takes us to 3.25% to 3.5% for the funds rate, consistent with the latest dot plot and consistent with the Fed's latest thinking based on what Chair Powell said in the latest press conference.
And then in 2023, we actually have nothing -- a continued 3.25 - 3.5% funds rate as the economy cools off, inflation comes down and the growth is below the long-term trend. And you know, I think in that environment, they probably would keep the funds rate somewhat above where they think it's going to settle in the longer term, because, you know, after all inflation is still too high. So I think the hurdle for cuts in 2023 is high. If I look at market pricing, the market was obviously pricing some pretty significant cuts, but I think that probably would require an even weaker growth environment than what we have in our forecast.
Tracy: (38:41)
So one of the unusual things about the current economic situation, and there are a bunch of unusual things about it, but just one of the ones that just one, one of the bigger ones I would say, is the difference between soft versus hard data. So the survey based measures versus the actual numbers that are coming in. So even though you look at things like consumer sentiment that survey is now at its lowest. And I can't remember exactly, but like very, very low, but if you look at the actual consumer spending figure, that's been relatively resilient. How do you explain that discrepancy?
Jan: (39:22)
Well, I think even among the soft data, there are some important discrepancies because the University of Michigan consumer sentiment number is close to an all-time low going back to the late 1960s. I mean, it just came off an al-time low, but it's still very close. But then the Conference Board survey, which is the other longstanding consumer confidence survey, is actually not particularly low. And that's a much bigger gap than normal. And it reflects the fact that the Conference Board indicator puts more weight on the labor-market situation. And people recognize that the labor market's still very strong. But yeah, confidence has taken a large hit in particular from the inflation increase and the increase in gas prices. I'd say you see a somewhat similar gap in the business surveys.
A number of the business surveys have fallen below the zero or 50 line, depending on which of the surveys you take, but harder indicators of activity are still somewhat firm. You know, industrial production generally has looked somewhat better. There are a lot of different indicators out there. I think you generally want to put some weight on a range of indicators. I generally take averages of different indicators and consumer confidence, I think, is probably a bit of an outlier to the low side or consumer sentiment. Rather, most of the indicators in my view are still consistent with positive, though very slow, growth.
Joe: (41:19)
I wanna ask you a question and it's sort of long term, and maybe it even is about the entirety of this coming decade. But when I think of the last decade, the dominant economic phenomenon to some extent was slack, and there was always ample workers ready to be hired. We had loose commodity markets. Oil was not only cheap. It was plentiful. It was the shale era.
And of course now it's tight commodity markets. And we've had multiple conversations with your colleague Jeff Currie. Tight commodities are expected to be a persistent feature of the economy, at least for the foreseeable future. It doesn't seem like there's gonna be some major change in the supply dynamic of copper or lithium or oil or anything like that. Does that change what this next decade is gonna be like? Does it impose, to some extent, a lower speed limit on what what growth can be in the years ahead?
Jan: (42:18)
Yeah, I think it potentially does. I do. I do think it's important from a speed limit perspective over time. Of course, there will be substitution and there will be innovation. And you know, whatever constraints exist in the short term can be relieved via investment. And you know, ingenuity. But I do think it’s a significant issue at least relative to the sort of post-2014 period when you had a much looser supply environment, especially in in the commodity industry, which then kind of begat the underinvestment for which we're now, we're now paying price.
You know, I think another issue, though, was on the macroeconomic side, that in the aftermath of the 2008 crisis monetary and fiscal policy were very reluctant to provide stimulus, even in an environment where we were still far away from full employment. And it took a long time for that to end. So I do think that it was the low inflation environment in part because of plentiful supply of commodities, but in part it probably also was, overly tight policy.
Joe: (43:48)
Do you find yourself, I'm just curious, you know, professional question. But obviously like on the podcast over for years and years now we’ve covered macro. And then in the last year, our conversations have become much more micro and we wanna learn about the ports and we wanna learn about copper production. And now when thinking about where are electricity prices gonna go in the US, you have to know how soon they’re going to get that export terminal in Louisiana back open that would presumably put upward pressure on natural gas prices. Do you find yourself in your conversations feeling the impulse to get more micro, to understand some of these things as how they're gonna inform the broader economy?
Jan: (44:29)
Yeah. In more of a crisis situation, I think you always have to learn more about details of the economy or the financial system or healthcare than you really perhaps anticipated. And that was true, of course, in the run up to 2008 and, you know, the immediate aftermath in terms of the financial system and and the mortgage market and securitization. And in the early days of the pandemic, it was around healthcare. And I think in the aftermath of the pandemic a lot is around supply chains and commodities. So I do think it's a hallmark in some ways of being in more of a crisis situation. The other thing I'd say on this is that different parts of the economy are having very different experiences. And that's probably going to continue to make it harder to figure out the macro, because, you know, you've got good spending still at pretty high levels.
And even in a decent macro environment, goods spending is probably not going to develop very well over the next year or so. Whereas service spending is still well below the pre-pandemic level. And even in a not-so-good economic environment, we probably will still see increases in office adjacent consumption or, you know, high-touch recreation services, travel, spectator events, and things like that.
I think that's also going to make it harder to extrapolate from kind of partial indicators about, you know, one sector of the economy, uh, to say that, you know, this is, this is, what's telling us that we're in a recession that we're not in a recession, and you really do have to look at the, the whole picture in, and, and, and the, you know, macro economy is made up of a lot of different, uh, sectors and separate micro indicators
Tracy: (46:38)
Just on this note, how has the pandemic changed the economy? I mean, you mentioned tweaking your labor market model, but I can imagine, you know, in the early days of the pandemic, when all this new fiscal stimulus was unleashed, there was some talk that, “Oh, this is a new paradigm that from now on, whenever there's a recession, we're gonna get, you know, the government writing checks and things like that.” But now that we have higher-than-expected inflation, it seems like that might be in doubt. So I'm wondering if you think that something permanent has changed because of our pandemic experience.
Jan: (47:16)
I think that's still an open question. On the labor market, we’re still kind of rethinking our labor market model. I don't think that's necessarily directly related to the pandemic. I think it's just thinking through how labor demand and labor supply interact in a more careful way. It just so happened that because we've seen these massive changes in job openings, that's what really made the whole job openings issue a very salient one. You know, I think how the economy is going to look from a structural perspective, you know, how much the average level of, say, service consumption versus goods consumption is going to be and, you know, how many people, how much time people spend in offices versus working remotely. I think a lot of those things are still somewhat up in the air.
My own view is, you know, probably more towards the side that a lot of these things are going to continue to normalize relative to pre-pandemic levels. So I think we've already seen a sizable amount of normalization. I think that probably will continue, although in a lot of areas it's taking longer than anticipated.
I think on economic policy, it goes in waves and there's always a risk of kind of fighting the last war for central banks and fiscal policy makers. And in the of 1990s and 2000s and much of the 2010s, I think central banks were very focused on high inflation and the risk of inflation recurring.
And so they tended to run too-tight monetary policy. Then in the course of the recovery they learned basically that they probably should be setting their sites on full employment. When the pandemic struck, they were very determined. “We're not going to make this mistake again. We're going to be very aggressive.” And, you know, in 2020, that was actually extremely fortuitous because they were very aggressive in stalling what could have been a significantly worse crisis. But then in 2021, you know, this thinking led them overdo it and it took too long to sort of bring about a change in policy. And so in 2022, they've been, they've been catching up.
Joe: (50:21)
I mean, yeah, it was late Jackson Hole 2020, that's when they unveiled the Flexible Average Inflation Targeting, which in retrospect seems like it might have been the ideal policy for the post-GFC recession. That might have led to better outcomes than we got.
So what's the buzz gonna be like at Jackson Hole? What are you going to be listening for?
Jan: (51:02)
I think the question of, you know, how, how do you think about demand and supply in the economy and, and labor market balance, and, you know, what will it take to bring the parts of the economy that central banks and the Fed can, you know, have some control over, back into balance and, you know, how much of the, uh, inflation is, uh, you know, perhaps driven by, by factors that they really can't control. I think that's going to be important.
The question you asked earlier about, you know, how do you trade off inflation still above the target against an economy that is maybe at risk of falling into a recession or has fallen into a recession? I think that's gonna be an important one. How do you interpret the dual mandate? To what extent do you put significant weight on both sides of the mandate, and to what extent do you really focus primarily on, on inflation and at what time horizon, you know, I think these are really the, the bread and butter, really central questions of macroeconomic policy that are going to be very much, uh, in, in focus, you know, at times in Jackson hole in the past, um, you know, they've talked about, uh, issues that are maybe a little bit further away from the, uh, you know, from these kind of bread, bread and butter questions, right. But right now it's really blocking and tackling central
Joe: (52:35)
I just wanna go back again to this question of like, you know, you mentioned fighting the last war and, that's a natural human phenomenon and sort of anchoring to old conditions or old paradigms, or thinking that we can't really see high sustained inflation. And you mentioned in your own models, what were the signs that things were more out of kilter than maybe people appreciated and you pointed to job openings. Is there anything else deeper that over the course of the last year that you might have learned or have incorporated into your thinking, or is it not much more than we should have picked a different input?
Jan: (53:22)
I mean, I think in general, the inflation indicators that, uh, you know, I think also have been important and, uh, were flashing, you know, Amber or orange or, or red, uh, in 2021, the supply delivery indices mm-hmm , I mean, were, you know, pretty extreme and a lot of the supply chain issues, uh, you know, quite, quite extreme and while they have improved in recent months, it took a long time for them to improve. Again, some of that was because of recurring shocks, right? But I do think these are indicators that are very useful and it's important to take them very seriously.
Joe: (55:42)
Just a final question. What else are you sort of looking out for right now? Like OK, obviously unemployment and the inflation data. But is there anything else big that will inform your thinking, especially going into the end of the year and thinking about whether the pace of hikes could even be faster than what we're expecting right now?
Jan: (56:03)
Well the pace of hikes could be faster, of course, if the inflation adjustment takes longer and the labor market adjustment takes longer. I think that's very closely related to these core issues that we've been discussing. I am focused, of course, on what happens globally. I mean, we're looking at, uh, at least a mild recession in the euro area, and if there is no Russian gas at all that will end up flowing, then, you know, potentially a significantly deeper recession. There is a question about these spillovers from that into the US. I would say if it's a supply side driven recession, because, you know, say German and industrial, German and Italian industrial companies, don't get gas and therefore have to shut down production, that may not have, you know, large spillovers, but there's also the question, you know, what happens more broadly in Europe?
There's an election in Italy on September 25th. There probably will be some nervousness in the run-up to that election, because if you have a kind of euro-skeptic government in Italy and you have increases in rates in the euro area and upward pressure on Italian spreads, the risk is that you revisit at least some of the European crisis experiences. Because there'd be a question of at what point can the ECB really step in if the Italian government is less willing to cooperate. So that's definitely something I'm focused on.
You know, the latest developments in China. Obviously we've seen a very strong rebound from the Shanghai lockdown, but the latest data, again, show that the renewed virus spread is starting to have a negative impact.
So, I mean, our China forecast has been on the more cautious side for a while. We're currently at 3.3% for the year as a whole for GDP growth. The government target officially is still five and a half. And frankly, I think the risks to the forecast are, probably, still pretty clearly on the downside. So there's a lot going on globally. You know, a lot of downside risks to activity despite the fact that we've still mostly discussed inflation today.
Joe: (58:56)
Jan Hatzius, chief economist at Goldman Sachs, always a treat to chat with you and with so much going on right now. Really appreciate you coming back on the show.
Jan: (59:06)
Thank you so much, Joe. Thank you so much, Tracy. Great to be with you.
Joe: (59:10)
Thanks, that was a lot of fun.
Tracy: (59:12)
Thanks, Jan. That was great.
Joe: (59:32)
Tracy, I always obviously enjoy speaking to Jan, I guess it's, you know, there's still a chance of a soft landing. But it doesn't seem that high, especially getting inflation down from say 4% to 2%. Seems like it's going to take a lot of pain, but I guess it's not outside of the realm of possibility when you look at the unemployment rate staying low, despite the drop in job opening. So I don't know, a few causes for hope maybe.
Tracy: (01:00:10)
I was about to say, I thought Jan’s point about the difference between job openings going down versus the unemployment rate going up is a really important one. But the other thing I would say is I keep coming back to historic parallels and I know everyone tends to reach for the 1970s or the 1980s, but really it feels like, and we've, we've talked about this before, I'm sure, but the post-1918 Spanish Flu situation, like that feels just really relevant to me at the moment, because you did have a period of high inflation there. You did have the Fed start raising rates in order to bring prices down and they did underestimate the impact that rising rates would have on the job market. So you saw a big contraction in job openings actually, and eventually that fed into unemployment and it basically tipped the US back into recession a couple years later. So I'm thinking...
Joe: (01:01:11)
Thinking like, yeah, that was a pandemic. Oh, go ahead. That was the other similarity. Yeah,
Tracy: (01:01:13)
Well that too. Yeah, obviously yes, there was a very large pandemic,
Joe: (01:01:18)
But it does seem like, you know, the big worry to my mind would be if we got some unexpected jump, a meaningful, unexpected jump in the unemployment rate over the course of a few months while realized inflation remains very high. Because again, you know, you could like look at the math and say, inflation should come down and inflation expectations are anchored, but we know that there's sort of this very heavy emphasis on like “We wanna see it. We wanna see evidence that inflation is coming down. That it’s coming down in a sustained manner. That it's month over month over month that it's heading back towards target.”
And we do know that initial claims have been picking up, corporate layoff announcements have been picking up, not massively, there hasn't been some like massive weakness in the labor market, but it feels like that would be the one worry, because then the Fed's in a really tricky problem of having to decide which is the fire it wants to put out: inflation or recession.
Tracy: (01:02:22)
The other thing that struck me, or that jumped out, and we probably should have talked about this a little bit more, but, uh, just what a terrible position Europe seems to be in at the moment. As bad as things are in the US in terms of inflation, it just feels like in Europe, um, there's the potential for things to get even worse,
Joe: (01:02:41)
So it's the combination of very high inflation, particularly headline inflation, but also core rising. And they have not seen the wage growth that we've seen in the US. And then, you know, there's all of the issues that never seemed to be solved about fragmentation of the bond market. And so the question is, do you need intervention to hold down Italian debt? And then the different politics. We need another Europe episode soon.
Tracy: (01:03:11)
Can you actually bring down inflation while also trying to, um, narrow the difference in bond spreads? Like that seems like a really big challenge, but yeah, we should do a Europe episode. Let's do it. That would be fun flashbacks to 2012. All right. Shall we leave it there?
Joe: (01:03:26)
Let's leave it there.