A 2023 Economic Forecast You Can Use (with Justin Wolfers)
Has inflation peaked? What will the economy look like next year? Are we heading into a recession? What will happen to unemployment and home prices? Andy has a lot of questions, and economist Justin Wolfers has educated predictions. They discuss how COVID continues to impact the supply chain, why unemployment numbers are so low right now, whether or not we’re in a wage price spiral, and some good news around the corner in 2023.
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Andy Slavitt, Justin Wolfers
Andy Slavitt 00:18
This is IN THE BUBBLE with Andy Slavitt. Look this year has had a lot of volatility to it. You know, I think we came through the two prior years and COVID dominated our lives. And this year, you know, we’ve had the war, we’ve had an election, we’ve had inflation, we’ve had an economy that has been really unpredictable. And I think going into the year, we really didn’t see this level of volatility projected, people thought there was some inflation, but it would be under control. We even had an episode about a year ago, where it was predicted that this point in time in place, it would be much lower. Now, the Fed has just met. And they while they did raise rates, again, they raised them in a smaller amount. And that is significant why that’s significant, because it means that the Fed believes that indeed, inflation is likely to be peaking. So that creates another set of questions around Okay, well, what will the economy look like next year, if inflation is peaking? If interest rates are going up, and not as quickly it may stop? Are we gonna have a recession, or we’re gonna start to see job losses? What’s going to happen to our assets, our stock market portfolio, if we have one, our home prices, the rent, we pay all of those things? We’re gonna get into now with Justin Wolfers, who’s going to lay out I think, in the most useful way possible, how we should be thinking about 2023, what’s gonna happen to the economy, and then as a special surprise, a week from now, we’re gonna have none other than Jessica’s wife, Betsy Stevenson, also an economist on the show, to talk about the practical tips that can be useful to getting through challenging economic times. I love Justin, he’s been on before. I think you’ll really get a lot out of this.
Andy Slavitt 02:18
Alright, Justin, welcome back to the bubble.
Justin Wolfers 02:21
Happy to talk about well, it’s economics today, isn’t it?
Andy Slavitt 02:24
It’s economics day today. Yeah, exactly. In the bubble. We’re talking economy. And I hope to talk about 2023 give people a sense of what to expect. But maybe the best way to start is by talking about 2022 and where we are now. But boy, I was just thinking back to like a year ago, someone tried to predict what this economy would have been like in 2022, you will get the wrong […]?
Justin Wolfers 02:45
In lots of ways. The one that I think most of your listeners are immediately going to is a year ago, there was a lot of talk that inflation would be coming down. This was the talk of […] transitory that we saw a few supply chain disruptions during the pandemic. And all we have to do is reopen the economy fire up the machine, just like Windows, you turn it off, you turn it back on, and it works better than ever. That’s part of the story. But actually, there was an amazing good news story that I don’t think we’ve spent enough time thinking about, which is just a couple of months ago, we hit the lowest unemployment rate in 50 years, 3.5%. In fact, 3.46%. This is two years after the sharpest, most dramatic economic recession of our lifetimes. And in fact, since the Great Depression.
Andy Slavitt 03:35
How are those two facts related unemployment, that’s a record 50 year low inflation that’s as high as it’s been in four or five decades?
Justin Wolfers 03:43
To let your listeners in on the secret there. What Andy’s doing is trying to create a cleavage between the community of economists, which is his question gets to the heart of the biggest macro-economic debate right now. So one side of it says high inflation is the direct result of unemployment being low. We sometimes call this the Phillips Curve. That is a tradeoff between inflation and unemployment. If you try and run the economy too hot, you have too many employers looking for the same number of workers. And that starts to bid wages up and wages are the most important cost for most businesses, forcing them to raise prices. And so that’s the view that these are very tightly linked. A different view is that what caused prices to rise was everything that’s gone crazy over the past two years, Putin invading Ukraine causing trauma to global energy markets, supply chain disruptions and snarls all around the world and container ships off the coast of LA and days and weeks to get stuff around the world and record shipping prices. In the generalized just COVID disruptions. We saw the largest overnight transformation in our lives and whatever you do big things complicated stuff happened slogging away, maybe including inflation. So, by this view, it’s the pandemic, Putin and bad luck that caused inflation. And it’s kind of a separate issue. And a separate miracle that during all that disruption, we managed to keep most people in work.
Andy Slavitt 05:20
So, maybe let’s talk about the status of some of the things that you mentioned. Let’s start with inflation. There’s some data points, and some people arguing that inflation has peaked. And this is, of course, important, because if you believe in inflation is peaked, then the Federal Reserve would stop bringing up interest rates, and it would reduce the risk of a recession. Other people say, hey, not so fast, and the Fed certainly seemed to send out messages saying, you know, we’re gonna be very hawkish on this. Has inflation peaked? And how will we know when it has? If it hasn’t?
Justin Wolfers 05:56
It’s almost certainly piqued. The way you’ll know, Andy, as you’ll hear a charming Ozzy accent come on your podcast and tell you that it’s peaked. But that’s not just me. That’s the mainstream view among both Wall Street and academic economists right now.
Andy Slavitt 06:11
Does the Fed believe it’s peaked?
Justin Wolfers 06:13
Yes, the Feds own forecasts show that he expects inflation to fall relatively dramatically next year. And then the year after that. Let me actually try and add a little more context. The debate is not between those who think it’s peaked and those who think it hasn’t. In fact, everyone who watches the numbers closely thinks it’s peaked. The question is, how far is inflation going to move from unreasonably high rates down? Are we going to move from rates of 7% or 8% down to four or five? Or are we going to move down to three or four by the end of next year? That’s the terms of the debate. Now, one thing I think is important to realize is, we all started talking about inflation in 2022, for the first time in 40 years, none of us experienced it or bothered thinking much about it or bother talking much about it for literally 40 years. And it became a really big issue analogues, gas prices are up, grocery prices are up, you just couldn’t help. But notice, if you’re running a business, you knew that you workers were putting a lot of pressure on you as well, just really important social issue as well. Now, at the moment, if you’re looking at where inflation is expected to be in about a year and a half’s time, you could think about the optimist saying it’ll be two points something that pessimists saying it’ll be four point something in the middle of the road being at three points, something, that thing I want you to focus on, there is not the disagreement, but the agreement, which is that inflation is going to move from really quite uncomfortable, you can’t help but notice it rates down to the sort of numbers that worry economists but not most people. Which is another way of saying my real forecast is that in a year, the general public and mums and dads will be a whole lot less worried about inflation.
Andy Slavitt 07:56
So let’s get into some of the factors that drive inflation and just get a sense of the status of some of the things the best we can, what are some of the factors that are still driving price increases and driving inflation? And I want to ask you about a couple specific things. Are we in a wage price spiral? And you can define what that is? Do we have healthcare costs and other types of services that are even yet to see the shoe drop, perhaps in terms of seeing prices rise?
Justin Wolfers 08:28
Right, so first of all, a wage price spiral is what worries economists and it particularly worries anyone who was alive during the 1970s. wage price spiral is when prices go up a bit, and then workers demand a wage rise to keep up with that inflation, that wage rise, then leads to increased costs causing further price rises, and things spiral out of control. Now, there’s no evidence of that, right now, we’ve seen inflation rise to rates of about seven or 8%, its highest wages have grown by about 5%. So in fact, workers been going backwards through this period, they’re not the ones pushing inflation forward. In fact, they’re lagging behind and barely keeping up.
Andy Slavitt 09:08
But Justin, and I don’t want to do to set her up. But there may be these are not representative, but feels like there’s been some very public things like for example, nurses asking for and getting 20% or so rate increases, forget the number 20. Don’t focus on that, per se, but other workers, you know, coming in, and at least the beginning of what feels like a wage price spiral where people are saying, hey, I need to make more money. You know, I talked to companies doing their own budgeting and they’re indeed budgeting more to pay workers because they’re still faced with, as you said earlier, a tight labor market. So why is this not a wage price spiral?
Justin Wolfers 09:45
One simple way of saying it is just there’s enough other stuff driving prices up right now, that when you try and do a decomposition, there’s not a lot of work left for wages to do. Another way of saying it, Andy is there’s two ways of tracking what’s going on in the labor market. One is to read stories in Wall Street journal. And the other is to track aggregate statistics that are built by surveying 1000s of firms across the economy.
Andy Slavitt 10:06
That sounds like hard work.
Justin Wolfers 10:08
Yeah, it is. But guess what, we fortunately employ a Bureau of Labor Statistics to do that work for us.
Andy Slavitt 10:14
Phew. I thought you’re gonna ask me to do it.
Justin Wolfers 10:17
It’s all about your favorite three letter acronym, would you believe the BLS? That’s those economywide statistics are the WSJ. That is the stories that are often told but are not always representative. Now, I do want to point something about it out about the stories that you’re hearing, because they are borne out in the data, which is employers of low wage labor, seeing very, very sharp pressures for quite dramatic wage increases. I’m kind of happy about that, frankly, if folks at the bottom are finally getting a boost, and folks at the top aren’t. Well, that reverses a story we’ve been telling for decade after decade. So that’s why it is possible to find the headlines you’re talking about. But those headlines aren’t coming out of, say, my employer, the University of Michigan, where I can guarantee you we’re in no wage price spiral here.
Andy Slavitt 11:05
Well, the other dangerous form of data to use, of course, is the anecdote. But I’m going to argue it’s slightly in favor of the anecdote in the following way. Everybody who goes to restaurants knows that there are, if they observe the check, there’s additional costs for things like health benefits, there’s, they know that they’re having a tougher time. If you talked to any restaurant owner, I talked to Juan Jose Andres, it’s getting labor, they’re raising rates and menu prices are going up. So again, you’re gonna tell me Andy, don’t pay attention to that?
Justin Wolfers 11:35
No, no, that’s not an anecdote. That’s data. Remember, we started by saying inflation has been 8%. So what you’re telling me is, you’re like, no, no, just no, I’ve got to contradict that. I have been to some restaurants. And I’ve seen the prices are rising. I’m saying, Andy, they’re the same thing. Prices are rising. But the question is that they’re gonna keep going up. And they kind of keep going up at the sorts of rates, we’ve seen them rise by so far. And the general forecasts are that they’re not let me clarify something in the minds of your listeners. It’s easiest to talk about this with gas prices, but it holds for a lot of things. When the gas prices rise. That’s annoying, it’s frustrating, it makes it harder to spread your paycheck far enough to buy the things you want to buy for your family. High gas prices suck. High gas prices cause inflation while they’re rising. But if gas prices stay high, they stopped contributing to inflation, because inflation is an ongoing rate of change of prices. And so a lot of things that frustrate the heck out of you right now are actually high prices, rather than rising prices. And inflation is all about rising prices, which is why you can be so annoyed to be overcharged at your local restaurant, and still have me saying inflation is going to be coming down. Those annoying prices aren’t gonna get more annoying.
Andy Slavitt 12:48
It was really the spiral effect that I was exploring. And I think you helped answer that, which is to say, the fact that it perpetuates, because people continue to ask for more wage increases. And indeed, employers like restaurants have to pay them, and therefore they have you seen in the menu prices. And I know that the phenomenon we’re most worried about is that that just keeps going that that perpetuates, right. And you’re telling us that no, that’s not going to perpetuate.
Justin Wolfers 13:15
At the moment, there’s no evidence that it is. And there’s been enormous fear over the past year and a half. So, at the moment, the report cards all positive. You’re not seeing more broadly, what I call an inflationary psychology. That is when Jose Andrews goes to set his prices for next year is he thinking all of his inputs are also going to rise again by 8% next year, in which case, you’d better go ahead and mark up his prices straightaway. And we’re seeing still, most people in the economy believe that this is going to be a passing thing. And that’s keeping us away from this self-perpetuating spiral, at least so far.
Andy Slavitt 13:53
We’ll, take a quick break and come back with Justin Wolfers. We’re going to talk about 2023 and what to expect after we do a quick break. Before we go on to 2023, I want to ask about two more things that impacted 2022 It just where they sit today. One is what’s the status of the supply chain if we’ve gotten that whole mess sorted out? Because we know that the Fed says that that’s the one thing they really can’t control, you know, they can control the demand side of the economy or influence it by what they do with interest rates, but the supply side kind of has to take care of itself. And when we talk about the supply chain, I should just be clear that what we’re really saying is that there just aren’t enough of some things that we all recall trying to buy things into just not enough in stock and that drives prices up, are we still witnessing that on the good side.
Justin Wolfers 15:01
So I’m glad you raised that. And I’m glad you added some clarity there because when people talk about the supply side, there’s actually a whole mess of issues they’re referring to. One important supply side shock is Putin invaded Ukraine. The good news, there is some, is he only invaded one country. And that caused energy prices to rise, but it didn’t cause them to keep rising. So that caused inflation to be high last year, but it’s not going to cause more inflation next year. And in fact, to the extent that energy prices moderate that will actually cause inflation to fall below what you would otherwise expect. The second is this issue of supply chains. And basically the issue here is take a look at your iPhone, all the parts that went into that little miracle in your palm right now come from all around the world. And they shipped around the world on big container ships. And they put together in a whole bunch of factories, the problems were huge issue still in China, by the way, a couple of guys at the factory walk in with COVID. And they shut the factory down. That doesn’t just stop part 18 B of the iPhone from being made that makes it impossible to make iPhones. The second problem is those container ships, too many of them were trying to move around the world all at the same time, we basically overloaded them. And they all got backed up at the ports, prices respond, which is become very expensive to send container loads worth of stuff abroad. So we’re seeing that there were very rough indicators of this, they’re not very good. But we’ve seen those really returned to normal, the amount of time it takes to get something around the world number of ships that are off the coast of LA things like that the amount of money it costs to send a container around the world. So they’re all getting back to normal. When those prices were high, they raised the price of imported couches. Now those prices have gone down, I’m not sure that they’re fully been passed through to cheaper catches yet. So that pressure is largely dissipated. And we sort of know that. And we’re waiting for the other shoe to drop, which is a lot of those prices to decline. And then let me give you the I try to be optimistic; I just want you to be the pessimistic supply is not going to be behind us for a long time. During a pandemic, flying fell off dramatically, for obvious reasons. They actually trained zero pilots during the pandemic, if you didn’t want to put one bloke in the air, why would you want to put two in. Also, older pilots felt this is dangerous. I don’t want to do it, and they retired. So what we have at the front end is two cohorts of new pilots who just never exist, it never appeared. So that missing generation is going to be missing for years and years and years. I tell the pilot story not because I care about PILOTs. But it’s a metaphor for nurses and teachers in many other parts of the economy. And so if I may just make a comment to your listeners, psychologically, we all want to leave the pandemic behind us were all spent too much time talking about it and thinking about it. And we felt too much pain. And it’s great to be out and enjoying life again. But when you’re doing your economic analysis, you can’t afford to forget it. Because the echo effects of this thing are going to persist and be an important factor in any thinking about the economy for years to come.
Andy Slavitt 18:14
Sure. One more 2022 question, I swear this is the last one. But it’s really kind of a two parter. The principal thing that most of us own our homes. And if we’re fortunate enough to have some portfolio, maybe a 401k, that has a bunch of stocks in it, maybe some bonds. So you know, it was a terrible year for the value of stocks. So people own It was a terrible year for the value of bonds that people might have owned at the beginning of the year. And you know, and of course housing prices, which were going up, up up up, or not, people may still have quite a bit of equity in their homes. But there’s not a lot of action people buying new homes. So I asked this because it matters to a lot of people, what they psychologically think they have as a safety net, often revolves around that. And of course, if you’re if you don’t own a home, of course, your rents are really going up.
Justin Wolfers 19:08
Yep. So let me start with stocks actually. He’s the advice to your listeners, the single best way to avoid financial headaches is not to check the Wall Street Journal every day. Maybe check in once a year. And I say this because for all the gloom and doom that’s actually that’s true about stocks, stocks have been falling for the past year and haven’t performed well. Let me give you a different comparison. On the eve of COVID, the stock market was at a lower level than it is today. So can you believe that you could bet money on the stock market? We could have the largest recession in a century and you would come out whole what a freaking miracle in so it’s more optimistic tone comes from just not thinking about the week to week or the month to month but thinking about your portfolio at a somewhat longer time horizon and I think it’s Literally astonishing that people still have most of their portfolios after the enormous shock that we just had that stocks, housing, housing is not just a financial asset, right? It’s a really big deal because you kind of also live in it. And we shouldn’t think about what’s going on in the housing market in purely financial terms, because we’ve also had the largest reorganization of urban and suburban life that we’ll see in our lifetimes. So any judging by what your listeners can’t see is the bookshelf behind you, I’m guessing that you’re working from home today. I am I am, too, I’m also guessing that if you’d called me at 4:30, on a Monday, three years ago, you would have been at the office. And so what I so work from home probably is increased the demand you might have for the number of square feet you want in the house, because now you want to be able to podcast and look after the kids. And so there are very real and very important adjustments happening to housing, and they’re still going to take some time to play out. So you’re right house prices have fallen over the past year. But By jingo, they rose so much over the previous year, that if you take in those profits from the previous year, and gone to the bank with them, that’s a fair bit of confidence. And so I think this housing thing still got a long time to play out as we’re going to see how much work from home persists, and whether people really want to pay the extra to live in the Bay Area in New York, or whether they’re happy to be in the sorts of areas I come to you from.
Andy Slavitt 21:22
So let’s talk about forecasting 2023. And maybe we’ll take it in a bit of the reverse order that we started in. So maybe we’ll start with asset values, which is the things that generally tend to cause some shocks, you know, seeing people withdrawing a lot of money from funds, which gives the fund managers you know, less money to invest, you know, high amounts of short interest in stocks, the things that would cause people to say, you know, we’re set up for the potentially risky situation overvaluation relative to you know, speculation, those sorts of things. Are there any conditions? Because I think the majority of it, I’ve only had majority, I’ve only looked at a handful of financial in preparation for this conversation, a handful of what the institutions are saying the JP Morgan’s the Merrill Lynch’s of the world and so forth. And their economists are generally saying that they feel seem more bearish, right. And I’m just curious, is there something in the data that you’d look at and say, yeah, there’s a story here.
Justin Wolfers 22:25
Right. So I’m going to give an answer in two parts. One is the economist at JP Morgan and Goldman Sachs and so on, are paid to sound confident even when they don’t know. And the most important thing your listeners can know is when they’re telling you stocks are going up or down. They haven’t got a clue or a track record. They’re bearish about the economy. So those guys are all writing newsletters to clients right now saying things like, there’s a 65% chance of a recession next year. That’s the sort of thing they’re saying. Now realize, I said asset prices, like stock prices or bond prices, they’re really hard to predict. But the ups and downs of the economy, it’s pretty hard, but not impossible. Usually, their story is inflation is high. what the Fed does with high inflation is it raises interest rates to choke off economic activity, and it might accidentally cause a recession. These guys on Wall Street now we’re absolutely convinced that the Fed is going to make a mistake and cause a recession. Now, I think 65% is too high. Because when people make mistakes, there’s lots of mistakes they could make. The Fed could overdo it and cause a recession. They could undo it. And we could have a dramatic boom. economists who often only talk about things that could go wrong. There’s also things that could go right. So that’s the main story, the main story on Wall Street is the Feds gonna screw it up. Now, the idea that guys on Wall Street know a whole lot more than guys that the Fed doesn’t quite ring true to me. The other exercise I did is I looked at all there’s a big survey of forecasters. It’s been running for 60 years. And they say do you think economic growth with negative next quarter, which is the beginning of a recession. And over time, that indicator has sometimes turned that a majority of economists are predicting negative growth. Usually that’s occurred in the second or third quarter of a recession. Another way of saying this is economists do a really good job of predicting a recession when already deeply in it. We have almost no track record of predicting next year’s recession with any great degree of confidence. Given that history, I think there’s an enormous case to be made for humility. So these guys might be right to be bearish think the economy is going to be bad. But the other thing they should do is look at history. And remember, it’s really hard to know if we’re right. Given that I think being so confident that things are going south is a little bit too much humility, I think should lead them to sort of have their estimate of the likelihood of recession. Look, I’m not as bearish as them. But another very simple rule for your listeners is never listen to one economist take an average for us all. So if I’m a little bit less bearish and they’re a little bit more bearish, take an average of the two. And that means do make some plans for what if the economy turns south next year. But also realize this sort of recession that we’re talking about is not like the 2008 recession was a global financial crisis. No one’s talking about that. The 2020 recession was a pandemic, of the likes we’ve never seen before, no one’s talking about that. So there is some chance of recession, they’re talking about a much more normal recession.
Andy Slavitt 25:31
So we’re going to do one final break and come back. And we’re going to talk to Justin about the fuller outlook for 2023, across a couple of dimensions that he’s just started to raise. So let’s talk about what’s going to happen in 2023. And let me begin by talking about the Fed, the Federal Reserve Bank, who’s this sort of actor and all of this, you know, I think you want to think she mentioned is the market sort of thinks the Feds going to blow it. And the Fed I think, seems to believe that the signal they send to the market is really important that they are going to get inflation and that they’re even willing to take the risk that people will think they’re going to overdo it. Because otherwise they’re worried about having sustained inflation. And that to them is their biggest fear. And I have to say, just like yesterday, I was in a grocery store. And I was walking by the soup aisle. And there were two people talking. And one woman said to another woman that she was pulling soup cans off the shelf. This is my hedge against inflation, soup, coming into buying soup. And I will say that, like the reason I raised that is because we’re also conscious of the economic hardship of people losing their jobs, and of a recession. But we don’t always think about the very real economic consequences of inflation. And so, you know, when I interviewed the Fed, you know, they made it clear to me that a percent inflation rate is just as bad as unemployment rate that’s four times as high as it should be in their minds. As we look at the coming year, how do you expect the Feds posture to influence what is going to happen with interest rates, inflation? And ultimately, whether or not we’re going to see a recession? Right?
Justin Wolfers 27:33
I think your characterization there is correct, which is right now much of the world thinks the Fed is a pack of clowns who are going to accidentally fall into a recession. And no one could be happier about that characterization than Jay Powell. Because he wants everyone to believe that high prices or high inflation next year is just unthinkable. And He wants everyone to believe that policy is going to be set in such a way that will never happen. If that’s the case, if I believed that inflation is going to be low, like next year like 3%, then I believe my input costs are only going to rise by 3%. So therefore, I only need to raise my prices by 3%. That’s the self-fulfilling prophecy.
Andy Slavitt 28:12
I think that’s so important. Can you say that, again? How that psychology of what people think the Fed is going to do actually does influence what happens?
Justin Wolfers 28:20
Yeah. So this is literally how I teach it in my econ 101 textbook. Imagine that you’re the manager at the local Outback Steakhouse, you can imagine why I use outback. And you have to print your menus for the next year. So you got to figure out what prices to charge for the next year? Well, if you think inflation is going to be low, then you think your input costs are not going to rise by much, well, if your costs aren’t rising by much, you’re not gonna have to raise your prices by much. Another way of thinking about this is if you think inflation is going to be low than you think your competitors aren’t going to raise their prices by much, well, if they’re not raising their prices by much You sure as heck better not. And so you’re going to print your menus based on your expectations of what inflation is going to be. So therefore, inflation expectations, in fact, translate into inflation, they become their own reality. It’s a self-fulfilling prophecy. The flip side, nothing terrifies the Fed as if all the managers of all the restaurants are sitting around and I think next year inflation is going to be 8%. So therefore, the price of the vegetables I buy is going to rise by 8%. And the wages I pay is going to rise by 8%, the energy costs are going to rise by 8%, I’m gonna have to raise my prices by a percent. And I also expect on my rivals to do that, then I’m going to raise my prices by 8%. No one else is going to win that becomes a self-fulfilling prophecy. So what we got is a happy self-fulfilling prophecy of low expectations, leading to low inflation and an unhappy one. And what the Feds got to do is sort of say, here’s the one that’s going to happen, and so tries to make it unthinkable that anyone could plausibly believe that inflation is going to be high next year. If it does that, if it screams and yells and says, If inflation is going to be high, I will cause a recession to get it down. Then everyone will believe If that inflation is going to be low, therefore everyone will set their prices to rise by only a small amount, therefore inflation will be low and the Fed will get what it wants, even without creating the recession.
Andy Slavitt 30:11
Okay, so let’s talk about that piece, you did a wonderful job explaining that. It also made me hungry. So let me head over the Outback later. But the ability to pull it all out without creating a recession is interesting, because so far the Fed would say, there’s been really zero cost to their raising of interest rates. And what I mean by that is they’re trying to manage two things inflation, and employment level. And so far, they’ve been able to raise interest rates without impacting employment level negatively. And they’re prepared for the economy, as they’ve said, they’re prepared for the economy to even shed jobs. And so far, it doesn’t even appear to be slowing down. Which means that for them in many respects, it’s costless. And obviously, they realize they’re inflicting pain on certain parts of the economy. But if they do have their dual objective that they’re targeted with, they’re not hurting one at the expense of helping the other they’re doing one, which is why probably some people think the critics think that they’re really at risk of pushing us into a recession, because they’re gonna push too hard on that. What’s your view?
Justin Wolfers 31:24
Right. So first of all, we agree that it’s no, it’s not costless. And I think no one in the Fed thinks it’s costless. If we raise interest rates, and as we raise interest rates, people spend less. If you had a brother and uncle a friend who worked in the construction sector right now, I guarantee you wouldn’t be calling it costless. Yeah, let me try and add a little bit of structure to how we might think about this. There’s a concept called the equilibrium rate of unemployment or the natural rate of unemployment in maybe, depending on who you are, you might believe that that’s 4%. This is just what people might regard as being the lowest sustainable rate of unemployment. And so you can push unemployment below that rate. But ultimately, it’s going to push inflation up. And so ultimately, you have to reverse course. And so if you believe that we’re currently below the natural rate than you think for every year, we spend with slightly lower unemployment, we’ll have to spend a year with slightly higher unemployment to offset it. In other words, inflation takes off. That’s the sense in which it kind of feels costless. Right? That it’s artificially low, we’ll have to bump it out officially hired offset. Here’s the deep problem. We don’t actually know what the natural rate of unemployment is. Yeah, in fact, a couple of years ago, economists were saying it was five and a half percent. And we’ve seen in fact, we can have a very functional economy. We saw it in the late Trump years, and we’re seeing it right now. We have a very functional economy with unemployment rate to 4%. Well, can we have really functional economy with an unemployment rate of three and a half percent? You know, the only way to find out is by trying. And so the real cost is that we’re wrong. What if we’re wrong, and this is not artificially low, but it’s actually trying to help the economy live up to what it’s capable of. And I think it’s really worth having that experiment and finding out because if we never find out, it could be that we’re capable of sustaining unemployment rates of two point something. If we never push it and find out, then we’re effectively saying millions of people should remain out of work forever. Because we can’t be bothered finding out whether the economy is a big enough place to bring them all in and keep them all included.
Andy Slavitt 33:28
This makes me think about something you said earlier, Justin, which is that there’s a possibility you talked about the two possibilities of how job growth and inflation were related. And one of the possibilities you gave was that they may not be related in this case, there may be something else going on. And that could be a kind of a structural thing, isn’t some of the answer to the question, caught up and trying to understand exactly what’s going on, there is something structural changed.
Justin Wolfers 33:56
So we have a guess, based on the structure of the economy as of 2018. Lots of people thought we couldn’t sustain unemployment below about 5%. Is the world the same today? I don’t know. But I do think there’s one really important historical experience, which is during the Clinton era. During that period, by about mid Clinton, the unemployment rate had fallen to levels we hadn’t seen in a generation. And there was a range of economists screaming, it can’t go any further, this is going to cause inflation slam on the brakes. And Clinton and Greenspan, in particular kept going, they were willing to push the boundaries and say, Hey, can we push this a little further than we thought. And every month unemployment got pushed down a little further and more people became integrated into the workforce and inflation didn’t take off. It was just a beautiful experiment that showed that what we thought was true was not in fact, true. And if we never ran that experiment, we would have consigned millions of people to the scrap heap. And so the same question arises, how far can we push here? And, you know, all of this comes out of a deep sense of humility. We economists don’t fully know on how the economy works, it’s a little distressing to admit. But given that, it would suggest you want to be really cautious about causing recessions, unless you’re really confident, it’s really important than is necessary to do so. And so the argument here is, can we be a little like Clinton, and also, by the way, this happened through Trump, late Trump, the unemployment rate was far lower than we’d seen in a generation, people were worried that this was unsustainable, and Trump said, dammit, let’s just keep going. And we saw that, in fact, very low unemployment rates were sustainable. One of the things we learned is that a strong economy is the tide that lifts all boats. And many of those at the margins of society had been written off as unemployable. It turns out, as soon as you told employers, you don’t have a lot of options, you got to work a little harder to find someone for this job, they’re willing to look a little harder. And one of the things that brings me great joy right now is reading headlines about employers figuring out new ways to employ the formerly incarcerated, or to bring the disabled into the workforce, they didn’t feel the pressure, so they didn’t do it. As soon as you got the pressure, they start to be a little more creative. And maybe we’ll see some of that going on over the next few years.
Andy Slavitt 36:10
Okay, so to summarize what I think I’ve heard you say, and for 2023, you know, the probability of recession, that the market probably gives a 60% weighting to you think is probably a little bit less than that you’re a little bit more bullish, that there is an argument not over whether inflation has peaked, but whether it ends the year not at six or seven, but as low as two or as high as four. And that is material that is material to that first question of whether or not we end up with a recession, and that asset values is really stupid question to ask you, and no podcast are worth their salt would, would ever ask you that question. But in fact, it really is hard to know, despite the fact that there’s probably more negative sentiment. But is that a fair synopsis of what people should be thinking about for 2023?
Justin Wolfers 36:57
Yeah, and let me just say one other way, economists are a distinction between the real economy how many jobs we have, how much stuff we buy, how much stuff we make, and the nominal, which is what’s going on with inflation. 2022 was a really good year for the real economy and a really bad year for inflation. 2023 is probably going to be a pretty good year on inflation coming down, and maybe somewhat less good in terms of the real economy.
Andy Slavitt 37:21
I want to close by just asking you if there are some structural things that have happened differently that put us in new territory, relative to management of the economy, and how the economy will behave in the future. And there’s a million ways you could take this answer because there’s a million different trends that are changing. You know, I think for the last number of decades, we thought we were globalizing. And now, I think there’s at least some trend towards people manufacturing at home. There are impacts from people moving from fossil fuels, to green energy. Are there structural things that have changed that did cause us to think and plan differently as humans?
Justin Wolfers 38:02
There’s a lot, there’s a lot going on in your mind there, Andy, and you must find it hard to slip.
Andy Slavitt 38:07
Have you’ve been asked a better question.
Justin Wolfers 38:08
I don’t think ever. So let me say a few things. The first dragon has to say sound contradictory, but they’re not. So through 2020 and 2021, I would go on podcasts like this. And I would say throw away your economics textbook. Not because the laws of economics have been suspended. But because the macroeconomics of a pandemic stricken economy are just fundamentally different than the macroeconomics of any other when people can’t leave the house. When goods find it hard to make their way around the world, things like that just the rules were suspended. So we’re all getting back to normal life now at some rate, and that means that the normal rules are going to reject good news, you can now go and buy a copy of your favorite economics textbook. It works again. But what is still going to be different. It’s something I alluded to earlier is the shadow of COVID will be with us for at least another 5 to 10 years. So this is in many respects. It’s the generation of missing pilots and teachers and nurses it’s going to take many years to work its way out of the system. There’s also what you could think of as the peloton economy. peloton made the mistake of believing that what was happening to bike sales in 2020 was going to change their future. Turns out peloton weren’t the only ones who did Facebook. And in fact a lot of the tech sector got way out over their skis and so this is deep question how many pelotons are out there? It turns out if there’s a lot of peloton then you’re more worried about 2023 than you might otherwise have. Then. You’ve also got other things like typically in a downturn if there is one people cut back on durable goods, you won’t buy a new dishwasher, you’ll let the old dishwasher keep just chugging along for a little longer. Well, if we all just redid our kitchens, then it becomes really easy for us to skip buying the next dishwasher for several more years and that will change the cyclical sensitivity of things. So again, the advice Your listeners is make sure you’re thinking about the ripple effects, or the echo effects of COVID. Because they will also think about the education of kids. They’re gonna be with us for years to come. Another is, I’ve always been quite cynical of oh my goodness, the world is changing. As an economist, I get breathless calls from journalists, aren’t we, in the middle of a massive structural change? People have been calling me every year for the past 25 years and the phrase they’ll use each time maybe we’re in the middle of a NASDAQ bubble, or maybe it’s something. And you know, my job as a responsible economist is to say, well, maybe but probably not. I’ve changed my chin. Because there is no question that the last two years is the largest structural shift in my lifetime. And I am as of yesterday, 50 years old.
Andy Slavitt 40:43
And Happy birthday.
Justin Wolfers 40:45
Thanks man, So there are so many things that if we are going to have a structural change, it’s going to happen now. Some of those could be in the political realm, some in the social. I think the best analogy I can come up with is to think about war demobilization war, demobilization gave us Rosie the Riveter and Rosie the Riveter gave us the entrance of women into the workforce, which fundamentally changed the organization of household life and changed where we live, who we marry all sorts of things. You know, I don’t see Rosie the Riveter right now. But I do see work from home, massive change in the organization of urban life of work and life. And it’s predominantly a white collar thing right now. But it’s certainly the biggest shock that I’ve seen in my lifetime. I’m less impressed by all this talk of de-globalization. I learned a new word yesterday, and I just want to share it with your listeners. It’s slow mobilization. Maybe we’ll globalize a little slower. But if you actually look at what Apple’s doing, Apple’s not de-globalizing, it’s just saying, let’s not build all the iPhones in China. That’s a little bit of diversification. But it’s not really bringing them back home. I mean, it’ll, it’ll do just enough to impress a senator, but it’s not really going to do anything at all.
Andy Slavitt 41:59
It may be the word of 2023.
Justin Wolfers 42:03
So you know, I think now is the time for those who think they see change. And I know that some number of your listeners and a very politically active so if I were an activist, now’s the moment, man, like, You got to get changed for the next two years and start to lock the doors behind you. Because I’ve never seen the capacity for economic, political or social change be as large as it is right now during my lifetime.
Andy Slavitt 42:26
Well, Justin, you’ve given us a lot to understand, in what is a very difficult to understand it impossible to predict kind of world. I just think about like a year ago, there was way more uncertainty than we knew. And this year, it may be the opposite. It may feel way more uncertain than it actually is.
Justin Wolfers 42:48
I think that’s right. In fact, it’s going to be gloriously boringly normal. That doesn’t mean I’m not saying there’s no recession. But if it’s a recession, it’ll be a boring recession. And if it’s a boom, it’ll be a boring boom. And all our forecasts will be wrong, but they’ll be wrong the way they normally are. There’ll be wrong by one or two percentage points, not 10 or 20. And so that’s the year I’m looking forward to. Great.
Andy Slavitt 43:11
Well, all the best Happy Birthday, good health to you. And, of course, your amazing wife, give her all our best.
Andy Slavitt 43:34
Thank you to Justin. Hopefully, you enjoyed that episode. I think he’s very, gives a really cogent sense of what he thinks it’s likely to happen. And of course, he’s willing to stake his claim to what he thinks is going to happen. Is useful as well. Friday show is a great one. I don’t want you to miss it. If you can’t, it’s a Friday conversation minutes about what’s happening with the big tech platforms. But from a different perspective, this argument back and forth about Elon Musk, and Twitter and all that there’s a larger context and that larger context, is this sort of question of what is the internet and the social media platforms become? And what rights do we have? Is their First Amendment issues at work? Is this a town square? Is there a duty to regulate and some of the worst things that are going on? And how should that happen? We got two great guests. That’ll be on there. And then next week, of course, is a holiday week Christmas, for some Hanukkah for others, other holidays still for others, and maybe just family time for some others. So we’re going to have a couple of best of shows, which I think you’ll really enjoy and they’d be back again in the new year. Look forward to talking to you in Friday.
Thanks for listening to IN THE BUBBLE. We’re a production of Lemonada Media. Kathryn Barnes, Jackie Harris and Kyle Shiely produced our show, and they’re great. Our mix is by Noah Smith and James Barber, and they’re great, too. Steve Nelson is the vice president of the weekly content, and he’s okay, too. And of course, the ultimate bosses, Jessica Cordova Kramer and Stephanie Wittels Wachs, they executive produced the show, we love them dearly. Our theme was composed by Dan Molad and Oliver Hill, with additional music by Ivan Kuraev. You can find out more about our show on social media at @LemonadaMedia where you’ll also get the transcript of the show. And you can find me at @ASlavitt on Twitter. If you like what you heard today, why don’t you tell your friends to listen as well, and get them to write a review. Thanks so much, talk to you next time.