Going into 2023, the conventional wisdom was that a recession was likely in store. Instead, it didn't happen. What we've seen is continued disinflation, even as the economic growth and the labor market have remained robust. Now going into 2024, there's growing optimism that a soft landing can be achieved. Stocks have been rallying, rates have been falling, and there's a widespread view that the Fed is done hiking. So will this come to pass? On this episode, we speak to Jan Hatzius, the top economist at Goldman Sachs, about why so many people got 2023 wrong and why he believes the soft landing is now within reach. This transcript has been lightly edited for clarity
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Key insights from the pod
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Why more disinflation is coming in 2024 — 4:07
What have rate hikes done to the US economy? — 9:42
The Sahm Rule and other recession signals — 12:31
What would be a worrisome signal from the labor market? — 14:52
What have economists learned about this cycle? — 22:08
The role of fiscal policy in this cycle — 23:59
Are there fiscal risks on the horizon? — 27:03
What explains consumer resilience? — 29:05
How should we think about recent strong productivity numbers? — 33:44
What will be the macro impact of AI? — 36:17
What to expect in 2024 overall — 39:07
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Joe Weisenthal (00:10):
Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway (00:16):
And I'm Tracy Alloway.
Joe (00:17):
Tracy, I would say the last few weeks, in a very real way, I would say optimism over the soft landing scenario, or at least the end of the rate hikes, has become like deeply conventional wisdom, I think.
Tracy (00:30):
I would agree with that, although I think it sort of started in the summer. We saw some inklings of it then, but you're right, it really seems to have crystallized in recent weeks. And of course the irony is that going into 2023, the consensus was really for recession. We had a number of people who were talking about the outlook for the economy this year and how bad it might be. And then going into 2024, it seems like we've completely flipped around. So the hills are alive with the sound of soft landings.
Joe (01:01):
I think you're right. Obviously 2023 has broken a lot of people's brains. Probably a broader theme, which is that the entire Covid cycle, people have been looking at it through the lens of a traditional business cycle or macro cycle. And it feels like a lot of that just hasn't worked, starting from probably the fast rebound in late 2020.
Tracy (01:23):
Oh totally. So I feel like the indicator that everyone was looking at in sort of late 2022, early 2023 was the yield curve, the inverted yield curve. And there was this discussion about how this is the traditional harbinger of a recession, but maybe things are different this time for a variety of reasons.
And then this year, fast forward to November, sort of late October of 2023, it feels like the other indicator that everyone is starting to talk about or was starting to talk about, is the Sahm Rule. So the idea that one measure of unemployment, the moving average, has been moving up. And traditionally this indicates an upcoming recession because unemployment increases non-linearly in every business cycle. And supposedly this was a hard and fast rule, but as we discussed with Claudia on one of our episodes of Lots More, again, maybe things are different this time.
Joe (02:17):
I do think it's important that you bring that up because it does feel like the labor market situation is kind of the fly in the ointment of the soft landing scenario, which is that there's clearly some kind of softening, I guess I would say, in the labor market. How far does that go? When will the Fed have to cut? Should the Fed be taking out some sort of insurance cut sooner rather than later to forestall a downturn, all big macro questions. We are nowhere near the end of understanding this macro cycle and I think we got to get a better handle on it.
Tracy (02:47):
The good news about this macro cycle is, I feel like 20 years from now, 50 years from now, there will still be studies coming out about exactly what just happened.
Joe (02:56):
Unambiguously, I am confident in that. All right, well we do literally have the perfect guest to help us understand this moment in macro what happened in 2023, what we should be looking forward to in 2024. I'm thrilled to welcome back onto the show Jan Hatzius, we've had him on a few times. Jan Hatzius, Chief Economist at Goldman Sachs. Jan, thank you so much for coming into the studio and coming on Odd Lots.
Jan Hatzius (03:21):
It's great to be back with you Joe and Tracy. Always wonderful to be here.
Joe (03:25):
Thank you so much. You put out a recent note and what I really loved about it is that there's this cliché that many market journalists, maybe even Tracy and myself at times, have used where it's like ‘blah, blah, blah happens, now here comes the hard part.’ It is just one of those things that people love to say. It's this trope, all the easy money has been made, now here's the hard part.
Inflation's gone down now, here's the hard part. You actually said the opposite. You said actually coming up next there's quite a bit of disinflation in store and that this stage of further declines in inflation should be the fairly easy part that we've passed the hard part of fighting inflation. Let's start there. What gives you confidence that actually regardless of what happens, there's more disinflation in the pipe?
Jan (04:07):
You're right, the title of our annual outlook report, which we published a couple of weeks ago, is that the hard part is over. The reason why I think the hard part is over is that we have a proof of concept that we can bring down inflation and rebalance the labor market without having to crush the economy and put the economy into recession and I think we've seen that very clearly in 2023.
We've seen it in the US but we've seen it much more broadly across G10 economies and EM economies that saw a big surge in inflation in 2021. Inflation has come down, if you take an average of all of these economies that saw a large and unwanted inflation surge across DM and EM went to 6% core inflation in 2022 was 6% come back down to about 3% on a sequential annualized basis without any deterioration in the labor market across these economies.
In some places you've seen some increases in the unemployment rate. We have seen some increase in the US and in others you've seen some decline, but the average actually has been basically flat. And to me that's very telling.
Tracy (05:27):
Wait, can I ask you something specifically about the US economy? Because I was reading another Goldman publication, this one in addition to the outlook that Joe just mentioned, this was sort of a Q&A between you and someone internal at Goldman. And they asked you about long and variable lags in monetary policy and you sort of suggested that you don't really think that's a thing.
So my question is how do you square the idea that the hard part is over, that there's more disinflation coming with the idea that monetary policy, maybe the long and variable lags aspect of it is over egged? Is it just a matter of degree? It's like the majority of disinflation has happened and now we're going to see little bits and pieces?
Jan (06:13):
Well, on inflation, I think we will see additional declines in a few areas. One that I think is very clear is housing. Rent inflation and owner's equivalent rent inflation is very likely to come down further. It's still running at about 6% on a sequential annualized basis and just looking at alternative rent indicators and where they've been running and continue to run, we would expect that to get back down to the 3% to 4% range by the end of next year.
In the core CPI rent and owner's equivalent rent has a 40% weight. In the core PCE index, it still has a 17% weight. So these are pretty significant reasons for expecting further deceleration. We've also seen a lot of labor market rebalancing, job openings have come down substantially, the quit rate has gone back to where it was in February, 2020. That is still feeding through to the wage numbers and I think that's another source of disinflation. And then there is still some disinflation to come on the core goods side. So in that sense, I think the lagged effects of what's already happened are indeed important.
Where I don't agree with the sort of maybe cliché of long and variable lags is if I think about the gap between a monetary policy shock and the maximum impact on the growth rate of GDP, which for me on the growth side is really the most important question.
How long does it take until I see the maximum impact on growth? We think that's only about two quarters, which means that since the Fed was most aggressive in tightening policy, starting at the June, 2022 FOMC meeting, the biggest impact occurred really in late 2022, early 2023.
And so it's quite important to think about what question you are asking. There are long lags in terms of the impact on inflation. There are even some pretty long lags in terms of the impact of monetary policy on the level of GDP. But as a forecaster, what I care most about is the maximum impact on the growth rate.
Because if I have a non-recession forecast and we've already gotten through the biggest hit from the tightening without the economy having entered a recession, now we're still seeing some negative impulses. That's not going to worry me that much because we've already survived the biggest hit.
Tracy (08:51):
Since you mentioned the non-recession call, I feel that we have to mention, Joe, that the last time we had Jan was in August, I think, of 2022 in an episode titled “The Narrow Path to Avoid a Hard Landing”, basically laying out a lot of the soft landing scenario that seems to be coming to fruition.
Joe (09:12):
Yeah, if we've been able to see all of this realized disinflation probably more to come without too much damage to the labor market, you know, the story goes, the Fed hikes rates, it slows demand, people lose their jobs, prices compress, but we didn't get the massive job losses. How do you even think about the link between the rate hikes that we've seen and the disinflation we've seen? Are they connected? Is it the kind of thing where it's not entirely clear? What has been the Fed's role in slowing down inflation?
Jan (09:42):
I think they're connected in the sense that the economy grew more slowly than it otherwise would've done. If the Fed had not not tightened policy, we would've seen stronger growth and higher inflation. But I think the primary reason for why this cycle looks so different, which by the way was the title of our outlook report a year ago “This Cycle is Different...”
Tracy (10:09):
Wait, how did you feel publishing that? Because I feel every time I say ‘this time might be different,’ I get really nervous because there's going to be dozens, probably hundreds of people online who are like ‘it's never different this time.’
Jan (10:21):
If you're not a little nervous, then you're probably not taking enough risk as a forecaster because you're never going to be certain. So I felt that that was our core view. And so I put it out there as the title of the report, but of course there's always a risk that you're wrong about these things and end up with egg on your face.
But what I was going to say is that I think the cycle is very different because as you said in the opening part, the core dynamic of this cycle really going back to the spring of 2020 has been Covid and its aftermath and all the imbalances that emerged either directly because of the pandemic or because of policy responses. Then of course we've also had geopolitical shocks, the Russia, Ukraine War in particular. But for me it's really Covid and the recovery from Covid that makes this cycle so different.
Tracy (11:36):
So I mentioned the Sahm Rule in the intro and I think that's been getting a lot of attention recently because it's been getting closer to triggering. I think the rule itself is something like if the three-month average of the unemployment rate, this is U3, is half a percentage point more or above its low in the prior 12 months, than the economy is in the early stages of a recession. And the current value is something like 0.33, something like that.
I didn't realize that Goldman has a similar rule. Apparently it's a 0.35 percentage point increase again in the three-month, I think, moving average of the U3 unemployment rate. How much attention are you paying to your own rule in the current context of a softening labor market? Is it a similar idea to what Claudia was telling us that, again, maybe it's different this time? I just got a chill when I said that.
Jan (12:31):
There are different ways of characterizing the data. It's a time series that goes back to the aftermath of World War II and it's certainly true, however exactly you want to define it, that significant increases in the unemployment rate have historically coincided with a recession in the United States. This is a historical fact.
Now, again, if this cycle is very different from past cycles, maybe that historical fact is not as relevant as it would be under other circumstances. I'd also note that we're only talking about 12 or 13 business cycles here and it's not a huge sample. And lastly, I would say if you go outside the United States, you also find that big increases in the unemployment rate have some predictive value. But the ‘rule’ in quotation marks doesn't work as well as it does in the US.
So when I take all of these things together, where do I come out? I would say significant changes in the unemployment rate is certainly something I would pay attention to, but I wouldn't elevate it to the status of something that tells you now you have to switch to a recession forecast if you do see a significant increase.
I'd also note a few other things just about this particular episode. Other labor market indicators have continued to be pretty strong. Payroll growth over the six months in which the unemployment rate has been going up as I think totaled 1.2 million or something on that order. The household survey employment numbers adjusted to the definitions of the payroll survey have shown its similar increase. Initial jobless claims remained quite low, not consistent really with a major layoff cycle. And so I take all of these things together and I would say I'm still pretty comfortable that the labor market is doing fine.
Joe (14:33):
When would you be concerned, and I guess the reason I ask is partly because this might determine when the hiking cycle, which everyone basically thinks it turns into a cutting cycle, at what point would you be concerned such that okay, the Fed is going to need to move and maybe take out some insurance to forestall a deeper downturn?
Jan (14:52):
I think it's always going to be a combination of indicators so I don't think I would want to necessarily draw a line in the sand. But if we were to see much more pervasive signs of labor market deterioration with jumps in initial claims and declines in payroll growth to something clearly below the replacement rate, so let's say in the 50,000 range or moving closer to zero and you get increases in the unemployment rate, that probably would be a reason to take out insurance.
And it's not limited to those indicators obviously, but if you get a combination of those indicators, I think it would be time to cut rates on the back of that. That doesn't happen in our forecast. Our forecast has payroll still growing above a hundred thousand a month and we have the unemployment rate going sort of broadly sideways, if not even a little bit lower over the next year.
And in that kind of environment, I wouldn't expect early cuts. I think it'll still be a while before the Fed does cut. But of course, one really important point now and that's very different from a year ago is that they can cut. They have the ability to respond to any weakening, foreseen or unforeseen by taking out insurance. And that's a really important reason for me, why I think the risk of recession is significantly lower than it was coming into this year. A year ago we had a 12 month recession probability of 35%. Now, we have a 12 month recession probability of 15% and a lot of the delta is the Fed's ability to respond to weaker numbers.
Tracy (16:39):
I definitely want to ask you about more responses to slowing growth, including potentially on the fiscal side, but on the topic of the labor market, so one of the other things we've seen recently in terms of a slight softening of the data has been job openings starting to come down.
And on the one hand people worry that this is a sign that the economy is slowing. But on the other hand, this could be interpreted as sort of good news. If you look back at the Beveridge Curve debate and the idea that the relationship between unemployment and job openings had somehow structurally shifted during the pandemic. When you're looking at openings now, A) how much stock do you put in that data, first of all because this is another big controversy? But B) what are openings telling you right now?
Jan (17:29):
So I think it's very important to distinguish between good softening in the labor market and bad softening in the labor market. So the labor market was clearly out of balance and overheated. We had a jobs workers gap, job openings minus unemployed workers, that was by far the highest level on record, a difference of six million, a ratio of something like two to one.
And that clearly had to be addressed in order to be on a path to non-inflationary growth and wage growth that's consistent with something like 2% inflation over time. So the decline in job openings that we've seen over the last year and a half or so, I think is very much a good thing because it puts us on a more sustainable footing.
Where are we now? We've seen a drop in this jobs workers gap from 6 million to about sort of two to 3 million depending on which measure of job openings you use. And I would put some weight on the JOLTS, the official Labor Department data. I'd also put some weight on the LinkUp data, some weight on the Indeed data. And that maybe answers the question about reliability a bit.
I do think these indicators are challenging and the Jolt series suffers from quite a low response rate and has been quite noisy. But if you combine it with other indicators, I would put some weight on it and I think it's telling us a broadly reasonable story that the labor market is still strong in terms of the amount of job openings out there, but it's less overheated and it's closer to normal, although still not back to where it was before the pandemic.
Tracy (19:17):
You mentioned the response rate on the survey coming down, and that just reminded me of something else that sort of falls into ‘this time might be different’ category. And that is that we have seen the response rates on a variety of economic surveys really come down quite dramatically in recent years. And there is this ongoing discussion of whether or not that might be clouding the economic picture.
So for instance, if you look at something like a consumer sentiment survey, these aren't the actual stats, I'm just making them up for illustration purposes, but if 50% of those asked are now responding to the survey versus 80% 10 years ago, you could imagine that maybe the people responding to the survey maybe they feel a little bit unrepresentative, maybe they feel a little bit more strongly about certain aspects of the direction of the economy, whatever. Is that on your radar and are you taking that into account at all? Is it causing problems for economists at this point in time or are you still sort of using a lot of the soft data, the survey-based data the same as you used to?
Jan (20:23):
I'd say you have to be aware of issues with economic data in a variety of areas. One thing that we actually have done over the last couple of years is probably put more weight on hard data than on soft data. And we are, I would say, pretty concerned about not just because of response rates and things like that, but just for sentiment effects.
Sentiment effects can sort of overstate a weakening of the economy. I think we've had a couple of instances in 2023 when the sentiment based indicators deteriorated a lot. And then even within, for example, business surveys, something like general business confidence was significantly weaker than questions that asked about orders or production or employment, which in turn was weaker than what the hard indicators were saying. And we have in those instances repeatedly put more weight on the hard indicators and I think so far that's turned out to be the right choice.
Joe (21:29):
I want to go back to something you said in the first answer, which is that we have gotten this proof of concept of significant disinflation and relatively mild, if not non-existent labor market weakening — especially if you look across G10 countries. There have been some, obviously the unemployment rate in the US has ticked higher, but globally it's pretty remarkable.
Does this tell us something about the degree to which economists understand the inflation process? Are there still more questions or do economists understand inflation except in weird business cycles that relate to pandemics?
Jan (22:08):
I think it is telling us that in this cycle there was a common global factor that has really dominated everything else and that's Covid. That's my main takeaway. Obviously there were quite a lot of differences in terms of policy responses across countries and that has had its effect here and there.
But the dominant issue that has faced the global economy over the last three and a half to four years has been Covid and the recovery from Covid and betting on effective convergence between different places, in terms of the inflation experience, I think has been the right approach so far. I'll give you an example.
The European, both Euro area and UK inflation data until recently looked significantly higher than what we were seeing in the US and Canada and maybe some of the EM countries. And what I just outlined suggested we really should be putting weight on convergence and indeed both the UK and Europe are now seeing significantly friendlier inflation numbers.
Tracy (23:14):
I want to press on this point because again, up until recently when inflation really did start coming down in Europe and the UK, there was an argument out there that maybe the US had outperformed because of the fiscal response in 2020 and beyond, which was absolutely massive on a sort of relative historic basis. How much weight do you place on the fiscal aspect of this at this moment in time?
And then also going into 2024, there is this open question about whether or not the US will have the same fiscal capacity to keep on spending or maybe do some sort of emergency stimulus if needed. So how are you thinking about that aspect of it beyond the monetary side of things?
Jan (23:59):
I think there are a lot of separate questions here. One is the size of the US fiscal response and then the impact of that on 2020, 2021 GDP. Clearly the US did a lot and that did have a significant impact on growth at that point. I mean, there was a huge fiscal boost and that supported activity and I think it was very important then it's been much less important from a growth perspective since then.
I mean, in 2022 there was a fiscal pullback which consumers were able to spend through in part because of a lot of the excess savings. In 2023, we actually don't get a significant fiscal impulse and by fiscal impulse, I really mean basically the change in the deficit and the growth relevant changes in fiscal policy. We don't have a big impact here in 2023.
It's certainly true that the US federal deficit is very large, 6% to 7% of GDP depending on how you adjust for some of the one-off items but it's a very large number, especially relative to a 3.9% unemployment rate. This is a very different deficit from the deficit that we had in the aftermath of the 2008 crisis when we also had a large deficit, but it was the flip side of a depressed economy.
And so this is more concerning because it's a structural deficit that will need to be addressed over time. I wouldn't expect it to get addressed anytime soon. I mean, 2024 is a presidential election year. Very little is likely to happen on fiscal policy and even beyond that, the path to how we're ultimately going to address this is not clear.
Joe (26:11):
In September and I guess the first half of October when rates were galloping higher, suddenly one of the big themes people were talking about was not just the size of the deficit, but the size of the interest payments on the deficit. Arguably the inflationary impulse of those interest payments in the sense that those interest payments are a fiscal outlay and then this idea of a snowballing compounding effect of large deficits.
When you say you're concerned or when you say it is concerning or at some point it would be need to address, what does that look like for you in terms of the problems that arise if politicians don't do something to close the structural deficit? And what would be the point at which it becomes a major problem for the economy if interest payments as a share of GDP start to become very large?
Jan (27:03):
I think it's hard to have a very crisp answer to that and I don't think we're close to a crisis point. I think over time though, if the deficit continues to be as large as it is now, or rise from here, maybe on the back of increases in interest payments as the debt stock gets rolled over, that is going to crowd out other types of outlays in the economy, it's clearly going to be an issue for the Federal budget itself. And it may, if we're in a broadly full employment environment, may also crowd out other types of private sector investments in the economy. Crowding out is a long debate in economics.
Joe (27:49):
What does it mean to you when you say it?
Jan (27:51):
It basically means that federal deficits squeeze private sector investment. There was a big debate about this again in the aftermath of the 2008 crisis. I was on the other side of that debate at the time because we had clearly an underemployed economy. We were away from the full employment level of output. And so there was no taking away from private sector expenditure because of fiscal deficits. But if we're going to be in a full employment economy, then I think it's going to be more of an issue.
Tracy (28:24):
Speaking of spending, this is a very clumsy segue, the consume. We haven't really dived into what's been going on with the consumer, but of course, if you look at the surprising resilience of the US economy, a lot of it seems to have been underpinned by consumer spending. So what's been driving that going into 2023? And then also what's the outlook?
Because again, going back to the soft data, you look at survey after survey and certainly spending time online and on Twitter/X, you do get the sense that people are struggling with inflation. And yet if you look at the hard data, the actual consumer spending number, I mean, it just keeps going.
Jan (29:05):
So 2022, you had a huge decline in real disposable personal income because of this inflation spike and the end of the Covid support payments. So real disposable income was down to something like 6%, the biggest decline in post-war history, much bigger than in ‘08, ‘09. But households were able to spend through it because of the stock of excess savings. So that stock of excess savings has now diminished and there's a lot of concern. What happens when people run out of excess savings? What's going to support their spending?
The answer is that real income is now growing and it's growing at a very healthy pace. In 2023, about 4% growth in real disposable income as wages are still growing at a decent pace, four to 4.5% headline inflation has come back down to the low threes so real wages are now going up. Employment is still growing at a healthy pace, interest income is rising while on the other side of the balance sheet, mortgage interest paid is barely rising because most people have third year fixed grade mortgages.
That's really the driver of continued increases in consumer spending and I think we'll see something similar next year. Maybe not 4% for real disposable income, maybe three or a little bit low three, but still enough to keep consumer spending growing in real terms at something like a 2% rate.
Joe (30:39):
One of the things that's a recurring theme on the show that we talk about a lot is this sort of acyclical investment. The green transition, all of the IRA spending, the tax credits, the various incentives, new battery plants, seemingly every day. It seems like 2024 is going to be another big year for a lot of sort of government incentivized domestic manufacturing. Of course you have chips, you have EVs, you have batteries, you have investments on tackling domestic sources of raw materials for batteries and so forth. How much does that buoy the US economy to keep a floor under activity? And how are you thinking about the sort of macro impact from some of these large pieces of legislation?
Jan (31:22):
So the numbers end up being relatively small if you divide it by $27 trillion, that being US nominal GDP. So I think these are very important developments in particular parts of the economy. Obviously in the clean energy sector they're very important. From a growth perspective, I don't think that's where the action has been. Even with this, we don't think that there's been a large or meaningful boost to growth in 2023 from fiscal changes.
Actually, the investments next year are probably going to be a little bit smaller than in 2023 just looking at some of the bottom-up project data. But there's still a high investment level in that part of the economy. It's very important for certain parts of the economy and from a climate perspective and clean energy perspective, it's not a major macro issue.
Joe (32:22):
One other big macro dynamic that, I don't know, it seems like it's in the realm of interesting or people are paying attention to it, but not sure quite what yet to make of it, is that we've gotten some good productivity readings lately and there's all these questions about, you know, A) how do you measure productivity, because it’s just sort of... Tracy's telling me over IB that I stole her question….
Tracy (32:46):
Joe asked for a follow up and then went to a completely different topic. No, but that's fair. Look, we're recording this on November 21st. Open AI has been in the news and certainly the idea of AI and productivity boosts have been in a lot of analyst research notes.
Joe (33:02):
Exactly. So how much of productivity is, in your view, something exogenous, a tech breakthrough that allows work to be done more productive? How much is it about, okay, this is just what happens in this stage of the cycle? Could it be a reverse hysteresis effect in which when you have periods of very intense high unemployment, then companies have to find ways to improve productivity?
Other theories are that it's actually a function of the employment mix and that if you have more people working in factories, etc., then you're going to have higher productivity growth than if you have more people working in daycares and healthcare centers where it's hard to achieve productivity. What do you make of the gains and what do you think are the prospects for something like this being sustained?
Jan (33:44):
The main thing is that the productivity data are always noisy and have been incredibly noisy in the last three and a half or four years. So I like to look at things over a somewhat longer time horizon and in particular, what's happened since the fourth quarter of 2019. The latest numbers are showing just under 1.5% percent annualized growth in non-farm business labor productivity, which is a little bit better than what we saw in the five or 10 years before the pandemic, but not by a lot, it's a few tenths.
I think that's probably a reasonable starting point of where we are from a productivity growth perspective. We do expect a boost from AI to productivity growth, but probably not for a number of years, I don't think. In fact, I'm pretty certain that we're not seeing that right now and I wouldn't really expect it over the next couple of years. Maybe late in the decade, we can see a lift there and I think it could be sizable, but I don't think that that's what we're looking at at the moment.
Tracy (34:59):
Joe, I just had a flashback. One of the first pieces you ever commissioned for me when we started working together at Bloomberg was actually one of Jan’s notes on productivity and how if you look at video games like Grand Theft Auto, I don't know if you remember this...
Joe (35:19):
Remember when I used to commission stories to you?
Tracy (35:21):
Yes, terrible times. Anyway, that was just a random walk down memory lane. But just on this topic of AI, one of the themes running through this conversation has sort of been, it's different this time. And in addition to things like AI and ChatGPT, we've had the supply side factors that we've been discussing, the role in inflation and things like that.
It feels like the economics profession has had to deal with these brand new sorts of topics or themes running through the macro picture from AI to supply side. How do you go about incorporating these new things into your research and your forecast? Because I can't imagine that, pre-2020 you were an expert, I mean, please tell me if this is wrong, but you were an expert on logistics or shipping or things like that. The same goes for us by the way.
Jan (36:17):
We've had to pick up an unusually large number of new things over the last several years. I mean, there's always some of that because the most interesting things that happen in the economy are often not ones that you can just look up in a textbook, but it's been definitely sort of an overload of new things to get smart on and be able to assess and AI is a great example of that.
The supply chain disruptions, the virus, obviously, is maybe the canonical example of something that most of us had no idea about and then had to get at least somewhat familiar with. I'd say you have to be eclectic in terms of what kind of information you're going to draw on. If I take AI for example, we've spent quite a lot of time looking at occupational classifications that the US Labor Department or the European Union put together that break down the labor market into, in the case of the US Labor Department, 900 occupations and then provide a pretty detailed accounting of what tasks workers in each of these occupations fulfill in order to be able to assess what part of this could be replaced by AI.
So it's pretty detailed quantitative work, although there's obviously a large speculative component to it because we're making informed guesses of what could be replaced. We don't know how powerful AI is going to be ultimately, but that's the sort of analysis that we've had to do in other contexts a number of times, especially in recent years.
Tracy (37:57):
Didn't you start looking, I can't remember the name of it, but the layoff filings?
Jan (38:05):
The WARN notices.
Tracy (38:06):
Yeah, that's it. Didn't you build an indicator for that? So what is that telling you now? Because again, in 2022 that was a big year for mass layoffs, especially in the tech industry, but maybe some of those big on mass layoffs have sort of eased a bit.
Jan (38:21):
It's not telling us anything very different from other, more conventional data sets like Initial Jobless Claims or the JOLTS layoff rate. And I also would say this one is a little bit closer to the beaten path. It's been around for a while and we're obviously trying to measure something that is very core to any economic model. It's definitely been a helpful indicator that has generally sort of told a slightly more reassuring story and continues to do so.
Joe (38:52):
So we just have a few minutes left. Let's talk a little bit more about 2024. I think you said right now your odds of recession are 15% in the next 12 months. You do see cuts on the horizon, just not imminently. Talk to us a little bit about how you see the next 12 months unfolding.
Jan (39:07):
We have, I would say on the growth side, more of the same two-ish percent growth. I mean the annual average we're 2.1% at the moment, which is a little bit below where 2023 is probably going to come out. So call that broadly trend growth with the unemployment rate going sideways to maybe a touch lower.
We have inflation still coming down from certainly on a year-on-year basis. We have core PCE inflation in the fourth quarter of next year at 2.4%. So still above the official target, but within the zone that I think would be pretty comfortable for Fed officials in that kind of baseline scenario. I don't think that the Fed is going to be in any hurry to cut. So we don't have cuts until the fourth quarter of next year.
Jan (40:03):
The risks to that baseline path for the funds rate though are strongly on the downside. It's very unlikely that we're going to see a significant amount of additional hikes, but it's very possible that we'll see cuts if there is more of an air pocket in growth than what we have in our forecast. And I certainly would, if I put myself in the shoes of Fed officials faced with a significant air pocket that looks like a bigger risk of recession, I'd certainly be very comfortable cutting in response to that.
Tracy (40:36):
I tried to ask Michael Barr from the Fed this question and was completely unsuccessful recently. But in terms of a slowdown in US growth or a recession indicator, if you had to choose one thing to look at, you know, you're stranded on a desert island and you can only look up one chart on your Bloomberg terminal, what would it be?
Jan (41:00):
It would be a labor market indicator. I mean, initial claims is, I think, a very traditional one. The unemployment rate would obviously receive quite a lot of weight. The payroll numbers, I mean, that's usually what tells you that a recession really has started. GDP is obviously heavily revised and can be quite noisy, especially after a 4.9% number in Q3. If you had a weaker number, you might want to average that. But if you have material deterioration in the labor market, something much more material than what we've seen so far, which I think is still very debatable, then that would obviously be an alarm sign.
Joe (41:38):
Jan Hatzius, Chief Economist at Goldman Sachs. Thank you so much for coming back on Odd Lots. That was great.
Jan (41:43):
Great to be with you. Thanks.
Joe (41:57):
You know what point I really like, Tracy, first of all, obviously I really enjoy talking to Jan every time. A point that he made and I guess I think it's also kind of a point that Austan Goolsbee made when we talked to him, economists talk about all these historical patterns, there are so few examples of all this, it sort of makes a mockery of the idea of statistical significance. The idea, it's like ‘Oh, we're going to build these rules on 13 events or four events.’ It always sort of blows my mind that people take that too seriously.
Tracy (42:23):
Well, how many business cycles was it that Jan mentioned? Like 12, something like that? I can't remember the specific number, but you're right, it's a pretty small sample. On the one hand, I can understand the allure of having a sort of hard rule that's grounded in, I don't mean simple in a pejorative sense, but simple rule if the moving average of the unemployment rate is above this, then it's time to watch out. That's intrinsically attractive and you can see why people would gravitate towards that. But on the other hand, I do take the point that in a business cycle that has been so unusual, you should be allowed to make sort of qualitative judgments on what's happening with the sort of hard data.
Joe (43:09):
I think that's spot on. The key thing is humility. Because A) you don't have a ton of examples and B) this is a very weird example. It just really was not, 2020 was not a normal recession. The policy response was not normal. The shift of consumption from services to goods was not normal.
There were many very weird things that happened over the last three years. The idea that these rules are formed based on a limited number of historical examples to apply to a situation that is not now seems like a very good reason for general humility. But as he points out, you look at the scoreboard all around the world and it's really not just the US. We've seen this decline in inflation without much labor market weakness. It is possible.
Tracy (43:54):
That's really interesting because again, like the explanation for it just six months ago was the fiscal response from the US and now maybe that's not so much the case if inflation is coming down everywhere. You know what I was thinking when you were sort of listing all those one-off events, it'd be really interesting to compile like all the things that are sort of unusual about this cycle because there are also less obvious ones. I mean, Jan touched on some of them, but the idea that the majority of homeowners now have locked in those 30-year rates so the pass through from higher benchmark rates just isn't there. That seems kind of unusual. There's so many that you could actually go through, the change in survey responses would be an interesting one, obviously the stuff we've seen on the supply side, I mean there must be dozens.
Joe (44:43):
It really is different this time.
Tracy (44:45):
You said it! It makes me so nervous whenever anyone says that, I feel like we're just tempting fate. On that note, shall we leave it there?
Joe (44:55):
Let's leave it there.