Joey Politano is an economist and commentator who writes regularly on his Substack newsletter titled, *Apricitas Economics.* Joey is also a previous guest of the podcast, and he rejoins Macro Musings to talk about the state of the US economy, inflation, Fed policy, and much more. Specifically, David and Joey discuss the results of the Fed’s ongoing rate hikes, the narrative that higher rates may lead to higher inflation, conducting monetary policy in a supply constrained economy, and more.
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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].
David Beckworth: Joey, welcome back to the show.
Joey Politano: David, it's a pleasure to be back on. Thanks for having me.
Beckworth: Oh, absolutely. And it's been fun to follow your work. I mean, you do a great newsletter and I recommend all of our listeners subscribe if you haven't already. But you also provide summaries of some of your pieces on Twitter so you can follow along there and you have very thorough graphs and comments. So, you're a very busy, very productive in this newsletter. Now, last time you came on, Joey, you were doing this out of the love of your heart. Now, you've gone full capitalist on us and I love it. You're an entrepreneur, you're living the American dream, you went independent, you gave up your full-time job, you did this and I'm really proud of you and there's been several others on the show who've done this. So, hats off to you, Joey, for living the American dream here and starting your own little business in terms of content provided in economic commentary. But tell us about that. How has that been? What's it like? What does it require for you to do? You get up in the morning and check the news. I mean, how do you that every day?
Joey’s Transition to Writing Full-Time
Politano: Yeah. It's actually been really crazy because I think the last time I was on here was more than a year ago. And so, this was still just me getting into this swing of writing. And as you mentioned, none of what I was writing back then was making me any money. It was just stuff that I was doing for fun and for my own personal growth, personal communication on Twitter. And it was about after that time, so a year, or so, ago I started thinking, "Hey, a lot of people like this." And when it was my full-time job to be doing other things, there was a very low limit on the amount of stuff I could write in a week just by virtue of the fact that it's squeezing into whatever free time I had. And so, about six months ago I decided, "Okay. If I'm going to do this, I should do it professionally. And if I'm going to do it professionally, now is the time to try it." So, I launched the newsletter as my own independent business. I was very, very thankful for the positive response, it was almost overwhelming the first couple months. And now, I've gotten into the rhythm where this is my full-time job now, it's now my full-time income, and it's what I do every day. It's definitely been really intense partly because writing is intense, partly because this is the busiest time in economic history to be writing anything barring, maybe, March 2020.
Politano: So, there's no shortage of stuff that I want to write about. Most of the time my thought process goes from something I know is coming out, a topic that I find interesting or important and then I'm going to do sort of the light research, which is in my mind a partially collaborative effort with Twitter, with the people I know online and with the people I know as professional resources in DC. I'm like, "Okay. I'm looking into this thing. I'm reading about the inflation data." I know that it's going to come out to say, "I'm going to have to do all this research about it." And then I start talking about it online, try to build from that conversation from the research I've done into a broader piece and then try to get that published. And then, normally, things keep happening. So, I get the opportunity to follow up on a lot of the things that I have written. And especially over the last year that's been crazy because a lot of stuff that I've written has changed so rapidly in such a short period of time that revisiting it is actually really important. And then very recently I basically did this series, I'm doing the series still, starting 2023 where I wanted to really broaden my horizons and say… we're both American. There's this tendency to just talk about what's going on in the United States. It's-
Beckworth: No. Totally. Yes.
Politano: ... bubble vacuum, nobody else is involved.
Beckworth: Right. Right.
Politano: And then there's all this beautiful information that's published abroad that doesn't get any attention because maybe it's not in English or it's inaccessible or it's just not presented to American audiences normally. And I had a chance to highlight a lot of that stuff. So, I wrote about South Korea recently, I'm writing a piece about Australia now, this piece coming out this Saturday is going to be on Ukraine and the Ukrainian economy. And all of that's only possible because I have all of this time to be able to thumb through the Ukrainian Central Bank data releases, which I'm very privileged to be able to do that now.
Beckworth: Wow. So, you're doing a lot of granular research as well as engaging on Twitter for conversations. And I would note, if you haven't seen his newsletter or his tweets, he doesn't give you just a highbrow 30,000-foot perspective. Joey gets deep into the detail, he'll break down the CPI into components. So, you do get a lot, which requires also a lot of work on your end, Joey. So, question though… So, if you're doing this newsletter, I mean, do you pay for data or are you just getting all the free data you can. I mean, how are you making this work as a business? Because it takes time, which is a cost to you, but might also take subscriptions to some other data sources or to other newsletters. What do you do to make it all work together?
Politano: That's a good question. So, I think to your first point, when I think about the newsletter… why would people pay for a newsletter when there's no physical way that I could compete with the quantity of output in The New York Times, The Wall Street Journal, The Economist, right?
Politano: The only way you're going to pay is if I go deeper. That has to be the value add is that whatever you're going to get in the mainstream publications, by virtue of being mainstream, they can only go so deep. And to retain an audience, I get to go deeper. I do pay for a lot of news media, these other Substack newsletters, other major media publications. But, basically, all of the data I write about is free. And I think there's a wealth of public data out there that people don't look at because there's so much of it, and because breaking it down is very time-consuming. And that's where I see like, "Okay. This is my value add." There's a great example of... There are these surveys that basically every major high-income country does for the last 20 or so years. They go and they ask businesses, "Hey, why can't you run at full volume production? If you're a manufacturing firm, why can't you run at full volume production? Do you have a shortage of equipment, materials, labor, energy, whatever?"
Politano: Those surveys are usually the most boring surveys in the world because 90% of the time they will ask, "Why aren't you running at full volume?" And the answer will be, "Because that would be too much. No one would buy that much product. We couldn't sell that if we wanted to." Of course, we're not going to run the factory at full volume all the time.” But over the last two years, all of those surveys have become suddenly very interesting because you can look and say, "Oh. Here are all the automakers experiencing the chip shortage." You can see exactly how many of them are complaining about material shortages. In this survey, it goes from zero to 90 percent, citing it in two months. That's really important. And this is a data series that nobody has paid attention to for two decades because it didn't tell you anything about the economy until now.
Beckworth: So, you're providing a comparative advantage, you're finding out these great data sources, connecting the dots and going deeper than an article in The Wall Street Journal. So, it's really neat, Joey, to see you flourish. And, again, I want to just note that you've been very successful, over 40,000 people follow you on Twitter. How many subscribe to your newsletter?
Politano: I think it's 23,000, which is-
Beckworth: It's huge.
Politano: ... an insane number.
Politano: And it's wild because you think of… the human mind cannot conceptualize more than 200 people.
Beckworth: Right. And they're paying… these 20,000 plus are paying you to hear your thoughts, to see your analysis. That's a great compliment.
Politano: And not all of them are paying. I would…
Beckworth: Okay. Well, a good portion of them are paying.
Politano: But, yes.
Beckworth: But also your newsletter, Twitter, but you're also getting recognition. And, again, I just want to champion you because I like seeing people like you be disruptive. You're disruptive to the profession, to other professional Wall Street newsletter writers. I mean, you're bringing something that's fresh, that's novel, and, of course, coming from Mercatus, we like creative destruction and we like to see young entrepreneurs like yourself flourish. But I was just going to mention that your work's getting recognized. I know Paul Krugman, I see him every other day it seems like, retweeting you or citing some of your work and he has four and a half million followers. So, your impact is obviously greater than just your immediate work, which itself is far-reaching. So, congratulations to that. And I think he also mentioned you in one of some of his columns too, not just on Twitter. He mentions you in the paper.
Politano: Yeah, which is wild, to see my name in The New York Times is very humbling. It was a very funny story because... So, the first time he publicly said something about me, obviously, I'm getting a bunch of people DMing me. I'm shocked. And I told my girlfriend and she humbled me immediately being like, "Who's Paul Krugman?" And I'm not saying that to be mean to him, it meant the universe to me, but it was just a very funny story.
Beckworth: Great. And I wanted to stress that because I wanted to recognize your accomplishments, but two, I want to use that as a segue into an area that you stirred up the hornet’s nest on Twitter recently, one of your tweets that went fairly viral. And what you did is you shared another tweet, I think you took a picture of what someone else had said, another prominent academic, will leave names alone here and just mention the tweet, what this person said. But this academic is reviewing packages for PhD programs at a good school. And this is what this person says, "My job keeps dropping as I go through 70 PhD applicant files. People with two co-authored papers and an interesting solo writing sample don't even make it to the top 10 in my pile. The level of knowledge, research, experience, and passion these kids bring to the table is just remarkable."
Beckworth: So, if you're some grad student and you see this, it's a little kind of… wow, it's discouraging, it's disheartening. And so, you take that and you have this kind of a tweet you add to it, you go, "The competition in academic econ is so cutthroat at this point that if you don't know that you want to get a PhD by 14 and how to get one, the odds are stacked way against you. It's a large part of the reason why the discipline is not diverse and why success is so hereditary." And then you have a follow-up tweet. "Am I personally mad that I'll never have a career in the academic econ? Yes. Do I think this is a broader problem? Yes.” And I concur. I think this is a broader problem that the gatekeepers of profession have set up such high barriers. And there are other PhD programs one can get into and still have a successful career, but high barriers.
Beckworth: And even when you past those barriers, you got to publish in the top five econ journals. And so, I want to hold you up, Joey, as a disruptor to that model. Again, you're publishing widely, have a large impact, dare I say more impact than many people in these top programs because you're getting read by people who read The New York Times, The Wall Street Journal, people who actually influence policy. So, if one were to measure true impact on society, you may have a much bigger impact now, this journey you're on, than had you gone into, say, an econ PhD program. So, I think it's great to see you and to hold you up as an example for disruption. Alright, well, let's move on to some actual economic discussion, some facts here. I could talk more about your business for a while, but let's move on to some actual economic discourse.
Beckworth: And I want to start with the state of the economy. So, you've written a lot of pieces and we'll mention them as we get to them. But I want to start with a question, Joey. It's bugged me and it's this, what happened to the recession we were supposed to have in 2022? So, I had a lot of people tell me, "Hey, the recession's coming." I was interviewed on a certain TV network, I won't mention the name. And I was always the one who's a little bit more measured and nuanced on there. I'd get on and say, "Yeah. We've had a negative quarter of real GDP growth." In fact, last year we had two consecutive quarters of negative real GDP growth and most of the people on this TV show beside me were like, "Ah, we're in a recession, it's happening. It's Joe Biden's recession."
Beckworth: And then I'd say, "Well, look at employment numbers. They're actually doing relatively well the first half of the year." And then they would throw at me, "Ah, look at the household survey. You're looking at that payroll survey." "Yes, it's overstating." “Look at the household survey, numbers are way down." And then the yield curve was inverting, "And look at the yield curve." So, all these scary, terrible things that were given to us. And lo and behold, I still haven't seen the recession, Joey. So, what happened... And I want to use that as a segue to mention two of your articles you you've written, I think, that touch on both of these areas. One article's titled, *America’s 2022 Slowdown* and then a second article, *The US Labor Market Was Stronger Than We Thought.* So, walk us through what happened last year and maybe where we're going.
The Current State of the US Economy
Politano: Yeah. I think this is an important question, and I think the most important thing to come at from is that first question, are we in a recession? To most people and for most economists, a recession is when people lose their jobs. What's going on in the economy besides that is really secondary. Not to say it's not important, but it's secondary importance to, are people gaining or losing jobs. And you're right, there was a lot of worry that the labor market was slowing, that if you were looking at specific surveys that things looked a lot weaker than some of the official data. And I, myself, was worried not that there was a recession in 2022, but that the slowdown in the labor market was worse than people appreciated. And, I think, the body of data that we have seen over the last year and especially over the last couple months, the numbers have come out, basically put that notion to bed entirely, that the labor market grew pretty substantially over the last year.
I, myself, was worried not that there was a recession in 2022, but that the slowdown in the labor market was worse than people appreciated. And, I think, the body of data that we have seen over the last year and especially over the last couple months, the numbers have come out, basically put that notion to bed entirely.
Politano: They grew across a variety of sectors that, even things that you would really, really expect to be hit terribly hard by raising interest rates, like residential construction, gaining workers or at least not losing workers in the latter part of the year as mortgage rates grow really rapidly. That's really surprising from a perspective of a lot of people in a year ago or more than a year ago when the Fed hiking cycle started. I think even if you ask people at the Fed, they would not have expected to be able to raise rates this much with employment growth being still really positive. But that's… the fundamental answer here is people did not lose their jobs in 2022, therefore while there was a really important slowdown, it really wasn't a recession.
Politano: So, that second part is, there has been a real slowdown. And you mentioned the two negative quarters of real GDP growth, which is important but shouldn't be overstated. The bigger things that I like to focus on are saying, if you look at real consumption and investment growth in the United States, so how much are people consuming and what are we building towards for producing in the future. Growth there basically plateaued over the last three quarters. So, again, not really decreasing, but growing at a very, very tiny rate. And that's a very small decrease in consumption growth and a really big decrease in investment growth, especially the housing market. And so, I liked this example that economists at Bloomberg had talked about on one of their shows, and I apologize in advance for forgetting the name, but this idea of a rolling slowdown where we've seen sectors of the economy get hit hard, housing has gotten hit really hard.
Politano: If you work in tech, that's got hit really hard. If you work in retail, that's got hit fairly hard. Manufacturing, that's getting hit a little bit now. But those hits aren't really coinciding with one another yet, and they're not really to the degree that would qualify as a normal recession. And for every sector that I just listed that's doing poorly, you could point to one like food service which is doing just tremendously well, comparatively. And so, the economy's definitely in a weird place. I think there's been a really significant real economic slowdown in the United States, one that's worth taking seriously, but the really doom and gloom predictions for 2022 can be put to bed pretty conclusively.
The economy's definitely in a weird place. I think there's been a really significant real economic slowdown in the United States, one that's worth taking seriously, but the really doom and gloom predictions for 2022 can be put to bed pretty conclusively.
Beckworth: So, I like that point. You mentioned that there are some sectors that are shedding jobs and probably tech has been, at least in the newspapers and media, it's been very apparent. Big names, Google, Apple, and others in Silicon Valley. But I like the point you stress is that despite these losses, overall employment is still growing, which means people losing jobs in those industries are probably finding jobs in other industries, may not be the ideal job, but they're finding work. We're on balance, we're still adding jobs to the economy. So, I've heard these stories of how Silicon Valley kind of sucked up all the high-tech, high skilled people and now they're shedding some of them, which opens them up to other sectors that had a shortage of those tech workers as a reallocation of labor going on that might be very healthful, very needed. And that leads to this other observation, Joey. And that is maybe some of the slowdown is needed, it's necessary. Maybe we're growing too hot, overheated beyond capacity, beyond potential real GDP. So, in your assessment, is the slowdown that we have seen, is it within bounds of what we would want in terms of bringing the economy into potential or is it something a little more serious?
Politano: I think so far if you had taken Jerome Powell when they started raising interest rates and you had given him, not the inflation numbers but the growth and employment numbers for 2022 ex ante, I think he would've said, "That's good. We're in a good place." And that a lot of that slowdown reflects some of these nominal factors, these inflationary factors easing more so than it reflects, at this point, a big dramatic fall in real output. I think everybody knows that if you're tightening monetary policy, especially how aggressively the Fed has been trying to tighten monetary policy, in the short run, that's going to have effects on real variables. I think for the degree that the Fed has tightened policy, the effects on real variables have been comparatively pretty muted, which is what you want. You want to be able to get inflation down without as much real economic pain.
Politano: And so, it's hard to say how much of this is “necessary.” In an idyllic, honey and roses world, you would like to be able to maybe protect the housing sector a bit more. We have a big housing shortage and we know that raising rates hits housing really hard. Maybe you'd want to say protect lower wage workers more, but those aren't really the tools that the Fed has at their disposal trying to fight inflation, and that's tough. But like I said, all things considered, the economy's in a pretty good place for the degree of monetary tightening that has occurred.
Beckworth: Yeah. It's been remarkable. The Fed has raised its target rate 450 basis points, four and a half percent, likely to go beyond that here soon. And that's a nominal rate. But even real rates, look at real rates, it's been going up rapidly. Yes, they were negative, but just the change from the very bottom to the top is unprecedented. I've looked back at other periods where we had sudden increases in real rates and this is pretty unprecedented. So, the fact that we've been as resilient as we've had does raise some questions. Is the economy less susceptible to interest rate changes? Maybe we have more intangible capital, maybe there's some other factors that makes it less so. But still even the magnitude, it just raises some questions. And I know I've had some guests on before that raise questions about the Phillips curve and some of our thinking of the relationship.
I think for the degree that the Fed has tightened policy, the effects on real variables have been comparatively pretty muted, which is what you want. You want to be able to get inflation down without as much real economic pain.
Beckworth: But let me throw this at you, Joey. You know I'm a big nominal GDP targeting guy and I know probably one of the critiques is, "Well, you need to get more granular, David." That's what I know you're thinking. Get more granular. But let me just throw something out that I want to hear your response to. So, if you look at where people thought the economy would be today based on the consensus forecast, and that's what I do with my nominal GDP gap measure or if you drew just a simple trend line, and I know trend lines at some point become outdated and that's why I do the gap measure. It's based on forecasts. But if you do that, you see the US economy in dollar terms as close to one and a half trillion dollars larger than had we stayed on this pre-pandemic trend or where we thought we would be at this point. Now, how would you interpret that? So, I look at that and say, "Man, some of that has to be the economy running faster than potential or excess heat. Some of that has to be dialed back." I'm not saying all of it because it's definitely a measure that's imprecise, but how would you interpret that big gap?
Interpreting the Present Nominal GDP Gap
Politano: Yeah, I'm generally on the same team there where I think if you had looked at the economy and inflation, specifically, through, say, late 2021, a lot of the inflation at that point was attributable to pretty narrow specific factors, it was attributable to things going on in the goods market and the energy market that aren't as influenced by monetary policy. And it really wasn't the broad-based inflation that people worry about when they think about the 1970s or inflationary periods in other economies over the course of the period since. So from late 2021 to today, you've almost had the inverse, you had Russia's invasion of Ukraine, but a lot of the shocks to energy at least that haven't as a result of that have faded. You've seen a lot of the shocks to goods prices fade, and at the same time you're seeing this massive bout of inflation that is pretty broad-based and in a lot of the cyclical sectors that reflect economic strength.
Politano: So, I'm thinking if you look at the Stock/Watson measure, which is looking at the cyclical components of inflation, that measure is at probably the highest level in 40 years? I have not checked what is it at recently, but it's seriously above the Fed's target. And a lot of that reflects housing, which we know operates with a lag, but a lot of this is just broad-based spending. Now, dialing that back, just a smidge, there are a lot of countries where if you look at the nominal pressures, if you look at nominal GDP, if you look at nominal labor income, they look significantly better than they would in the United States, keeping just above trend or just the low trend in a way that isn't the US where we're significantly above trend, like you said, 1.5 trillion, which is a big amount. And a lot of those countries also have really big inflation problems.
Politano: I'm thinking about the United Kingdom, I'm thinking about a lot of places in the European Union, thinking about Australia and to a lesser degree Canada. And I think that really reflects... part of this is global factors, still. Part of this is a natural result of reopening from the pandemic, just having this turn-it-off, turn-it-on again, economy that in the grand scheme of things, we're only three years into. It's hard to come down on a precise amount for that. But I think the US is definitely on the side of a lot more inflationary spending, a lot less real shocks, especially compared to a place like Europe. But I also don't want to come out and dismiss it and say, "Okay. It was just the Fed. They were the only ones who got it wrong. Nobody else on planet at earth had this problem." Or, similarly, I think it's reductive to just blame the fiscal spending that occurred, mostly, at this point, almost two years ago, where it's like, "Okay. At some level that has to have already worked through the economy." I think what we're learning at a global level is that the level of real interest rates the economy can handle is significantly higher than what it was before the pandemic.
I think it's reductive to just blame the fiscal spending that occurred, mostly, at this point, almost two years ago...I think what we're learning at a global level is that the level of real interest rates the economy can handle is significantly higher than what it was before the pandemic.
Beckworth: Let me push back a little bit on the notion that fiscal policy has completely gone through the system. And I may be wrong on this, but what about all the excess liquidity sitting in household checking accounts? All those extra dollars there, some observers will say, "Well, what we really need to get to the other side of this is for households to spend all that down or get it into more sustainable levels." And therefore the fiscal injection didn't all transpire within a short period. It's taken its time to work through the system and we're still working our way through that. Any thoughts to that?
Politano: Yeah. I would say a few things. So, first, partially agree with that sentiment. We have this big bout of excess savings in the United States. This idea that a lot of people were receiving income in 2020, 2021 and could not spend it and a decent chunk of that income was fiscal transfers, it was the stimulus checks and expanded unemployment and what have you. But I will also say, you look at countries that did either much stingier fiscal transfers or no direct fiscal transfers and you still see that big excess savings pattern and you can see countries where the excess savings really isn't being spent down that aggressively. Also, they have pretty high inflation.
Politano: And so, I think it's a factor. I think the excess savings are really important. But I think part of that is just, if you think about it from an income distribution perspective, the people at the very top of the income distribution earn a disproportionate share of the nation's income. They also had much higher savings rates in the early part of the pandemic because, in general, they have more higher savings rates and more of their spending is discretionary. So, if you're saying, "Hey, we gave these transfers to..." It's a little silly to be like, "Hey, we give this stimulus check to someone in 2021 and they made less than $50,000 a year and they haven't spent it yet." I think that's a very small portion of people. I think a lot of that has gone through the system and if you even just look at the deficit in the United States, that's shrunk pretty dramatically over the last year or so. So, if you're thinking about what's the fiscal impulse, it's definitely tightening.
Beckworth: Okay. So, take the cross-country perspective to get a better sense of how important and consequential, as well as the distribution of these holdings. I will mention it's interesting to look at the terminal rate, and we'll come back to this in a little bit, the market's expectation of where the terminal rate will end up has been climbing recently as you know, but it's also been climbing in Europe. So, you mentioned Europe is having to deal with inflation and yet they don't have really excessive nominal GDP growth or nominal income growth. So, it's interesting to see multiple countries really raising these rates much higher, maybe speaks to the point you raised earlier that maybe we can bear higher real rates, but we'll see. I'm a little worried that maybe the long and variable lags may still come back to bite us in the rear. I don't know if that will be the case.
Beckworth: But with all that said, with all this said about how well we've borne the Fed tightening and all of these particular details that are important to understanding the story, I want to go back to a meme that you shared on Twitter and it's the meme where you have the guy who's crying, kind of poor drawing of a guy crying, and then you have someone with a vacuum, the Fed sucking up dollars and I believe the guy says, "No! You can't tighten policy into supply side inflation," or something along those lines, which was a view, go back to early 2022 when the Fed was starting its cycle, many people were like, "What are you doing Fed? You can't do this. And if you plan to raise rates as rapidly as they did, you're definitely going to create a recession," so, this doom and gloom that you mentioned earlier. So, speak to that. I mean, how far off was that meme or the expectation in that meme that we're going to destroy the economy because this is all supply side inflation?
Evaluating the Results of Ongoing Fed Tightening
Politano: I think that was... In retrospect, that meme was very prescient. And I'm also conscious of the fact that explaining a joke makes it horribly unfunny. But, that original joke was someone in 2020 complaining about the Fed doing all of this stimulus.
Beckworth: Oh. It was 2020, okay.
Politano: Right. So, someone made this joke saying, "You can't stimulate the economy in the middle of a recession. All you're going to do is cause inflation. You're not actually going to..." And the joke was that the Fed was still printing money anyway. And that was important at the time because unlike in the 2008 recession, we got a nominal recovery and we got it really quickly. And I think, comparatively, if you look at the real economic outcomes compared to the 2008 recession, it has been much better. And that's weird to just think about that the worst pandemic in modern human history compared to the financial crisis, the pandemic had less of an effect on the real economy on net partially because of how the Fed responded.
And I think, comparatively, if you look at the real economic outcomes compared to the 2008 recession, it has been much better... The worst pandemic in modern human history compared to the financial crisis, the pandemic had less of an effect on the real economy on net partially because of how the Fed responded.
Politano: And so, I had adapted that meme when the Fed started tightening because people expected this and they worried about a really big slowdown, worried about a recession, worry about losing employment gains that were really hard fought. And I sympathized with a lot of those worries. So, partly, it was a way for me to cope and be like, maybe I shouldn't worry that much. But, partly, it was really prescient in the sense that the economy has withstood that tightening much better than I think a lot of the doomers, including myself, expected. And I'm just going to say a couple examples that I remember that Jason Furman, I remember he tweeted something in 2021 where he was like, "Oh. If you follow an NGDP targeting perspective, you should support raising rates to 5% over the next year because that'll get inflation down."
Politano: And I was responding saying, "No. If you're picking a rate to target NGDP, you have to pick the rate that's correct.” And the 0% rates that we had in 2016 got us low NGDP growth. Before the pandemic, I don't see why a 0% rate would get us higher NGDP growth after the pandemic. So, I had egg on my face for that one. But I was remembering when the Fed started raising rates, Jon Steinsson, who's professor of macroeconomics at UC Berkeley, he tweeted, "What do I think the Fed should do?" He said it was raise rates 25 basis points every other meeting to get to two and a half percent, stop if the economy slows down. And people were in his mentions being like, "This would be a disaster. This would destroy the economy. This would cause a recession. Why do you want to go raise rates so quickly?"
Politano: And that was less than half of the tightening that was actually done over that period. And I think if you had talked to Steinsson and if you had told him when he made that tweet, if you had told him, "Hey, what would you think about raising rates 5% in a year?" He would've been like, "No, no, no. That's too much." So, like I said, I think the thing we're learning in the very short term is that the economy is able to handle higher real rates to generate similar nominal growth, similar inflation that we experienced before the pandemic. I will temper this a bit saying I don't want to get runaway on the good economic news train. I do think there's still a significant recession risk in the United States, for the world economy, but I think that those risks have been decreasing now for the last eight months. And also, obviously, it hasn't happened in the last eight months. So, if the outlook is improving and the economy is still trudging along, I think it's safe to say it's doing better than people anticipated in a lot of ways.
Beckworth: Yeah. Well said. And I'm one of those people who was in Jon Steinsson's mentions. I was definitely one who responded and said, "Whoa. Slow down, cowboy." Now, my motivation was responding to his... I believe his justification was the Taylor principle that you've got to increase rates one for one at least with the rate of inflation. And I'm like, "Yeah, yeah, yeah." And I shared this article that an academic had written that when you do the Taylor principle and you think about it, you got to look at a longer horizon. Don't look at just what inflation is today, look at what's expected over, say, three or four years out. And I was showing him breakeven forecasts. "So, look, the market is not expecting some massive number, therefore we don't need to have these rates." And lo and behold, the breakeven forecasts were way off. Right?
Politano: Right. Sympathetically, at the same time, if you're looking at a market forecast and saying, "Well, this is the best information that we have at the moment," I think that's still a good way of approaching it. Just like you said, acknowledging that lot of people got it wrong, including financial markets as of 2020. If you looked at breakevens early in 2022, they rose really dramatically before the Fed started hiking, which to me was this information update very slowly of like, oh, the economy might actually need higher rates and then the Fed's not going to deliver that. And then the next information update was, "Oh, the Fed's definitely delivering that."
I think the thing we're learning in the very short term is that the economy is able to handle higher real rates to generate similar nominal growth, similar inflation that we experienced before the pandemic...I do think there's still a significant recession risk in the United States, for the world economy, but I think that those risks have been decreasing now for the last eight months...So, if the outlook is improving and the economy is still trudging along, I think it's safe to say it's doing better than people anticipated in a lot of ways.
Beckworth: Right. Right. Well, let's use that as a segue into inflation and the outlook for it. So, let me just recap what we saw last year in 2022, inflation peaked in the middle of the year. June 2022, CPI hit 9.1%, this is headline. PCE hit 7%, the cores were a little bit lower. And then they came down, they've been trending down, which is good news. And I would also note that forecast, if you look at consensus forecast, they have it between 3% and 4% by the end of the year, market forecasts are also coming back down. So, this is progress, right?
The Current Outlook for Inflation
Politano: Yeah. I think that there's been a lot of progress as a result of the Fed tightening cycle and as a result of the natural slowdown of the economy. I'll say a few things. The first is that we know because of how housing inflation is measured, that there's a lot of disinflation in the pipeline and it's going to come over the next year or so, year through Q1 2024. Because the consumer price index tracks average rents, essentially, you can look at new rents and forecast where it's heading. And new rents, growth in new leases, has been decreasing really rapidly. I'm thinking of, if you look at Zillow data or Apartment List data, don't quote me on the exact numbers, but I want to say Zillow has grown 5% over the last year and Apartment List about three and a half.
Politano: Those are fairly normal numbers consistent with a 2% inflation target that you would expect to pass through over the next year. So, you expect housing inflation to slow down pretty significantly. I think, likewise, the Fed, Jerome Powell has been talking a lot about core services ex-housing, which they view as the big indicator of labor market pressures on inflation, and what the Fed should be doing to now cast inflation pressures, look at this indicator. And if you believe that that's wage driven, I don't believe it's as wage driven as the Fed does, but if you believe that that's wage driven, the White House has done this great analysis where they look at the wage growth in those sectors and it's come down significantly. So, I think in the big categories that are most cyclical, most influenced by monetary policy, we have a lot of disinflation in the pipeline.
Politano: Obviously, food and energy are hard to forecast, but we know just by the fact that gas prices were really expensive last year, that energy prices are going to be a negative contributor in the near future. And goods is actually a really interesting one. I remember the last time I was on the show, we were talking about this, and I'm sure you talked about this with, probably, a dozen guests at this point, where you have these impacts on supply chains that is felt through goods markets that pass through to car prices, furniture prices, all these manufactured goods that the Fed doesn't feel like it controls, that are supply issues more or specific demand issues where everybody suddenly wants a consumer electronic that they didn't want before. It's been really interesting that we've essentially gotten no relief on that front, on net. Certain components have come down, used cars came down a lot. But if you look at goods prices, they've really just held steady over the last year or so.
I think in the big categories that are most cyclical, most influenced by monetary policy, we have a lot of disinflation in the pipeline.
Politano: And if you look at used car prices over the last few months, they've actually increased, not in the official data but in wholesale data. So, I think the big forecasting error I made in a lot of senses was thinking these supply chain issues, because they're their supply chain issues, they will be transitory, they'll go away relatively quickly. I think we're seeing them go away now. If you look, there's a great survey that the Bank of Canada does where they ask firms about supply chain issues, and that number is at the lowest since the start of the pandemic or really since about 2021. But it's still double what it was before the pandemic. And so, I think that those pressures are definitely alleviating, but it's been remarkable to me how long a lot of those supply chain pressures have persisted for. Skanda Amarnath, who's on Twitter as Irving Swisher, he's at Employ America, he's been tracking this for a while. And it's funny, in the ISM manufacturing survey, they ask about supplies that are hard to find and there's been answers that have come up consistently since 2021. For every month they've done the survey, people have complained about this being hard to find. And that's pretty remarkable from the perspective of inflation forecasting. We've not gotten any relief on these idiosyncratic goods, supply chain stuff yet.
Beckworth: That's interesting. I was just listening to a podcast about a Chinese furniture firm that's building a factory in Mexico. They're actually moving production to Mexico and they're still having a hard time getting all their inputs, but they're getting there. So, maybe part of the story is there is this massive structural shift taking place and supply chains are still being sorted out and we’ll eventually get to that point. I made that same outlook. Look, we know there's going to be goods deflation given globalization, it will return, it hasn't. But does that mean then that in addition to the disinflation we are expecting from housing, this could be another tailwind for disinflation that the supply chain will still have room to work out, have opportunities to push down the prices as well as what we're going to see from housing?
Politano: I think so. And like I said, there's a lot of surveys that I look at. The US ones actually come out last, which is frustrating. But like I said, if you look at surveys on the European Union, Canada, Japan, Mexico, they all say that the supply chain issues are improving. And I think that there are some components where the lead times that were very insane are actually coming down now. But at the same time, I don't want to be burnt again here. I've been looking at the car market for three years being like, "They'll fix it eventually, right?" And things have just continued to be bad. It's actually funny because car production in the US fell again over the last few months below where it was in 2019, thanks in large part to these supply chain issues. And so, I think we're being forced to learn about how complex and interlocking a lot of good supply chains are nowadays.
Beckworth: And that's why your analysis is so valuable. You go very granular and it's important to do so. You can't just do simple aggregate demand and supply models I like to do, so, good stuff. Well, let's move to an area related to this and that's Fed policy. And before we jump into that, I want to bring up something that you've mentioned on Twitter. And I've also engaged in this conversation on Twitter and that is the claims of some observers that the Fed raising interest rates may actually cause inflation to go up. Now, some of our listeners might be thinking of neo-Fisherianism or thinking of Turkey where the president there is making that argument in the reverse direction. He argued lowering rates will lower inflation and, of course, that's turned out completely opposite to the truth. But walk us through that. Who's making this argument and what has been your response and engagement to it?
Higher Rates = Higher Inflation?
Politano: Yeah. So, it's an interesting coalition. I think I've heard these arguments in one form or another a lot over the last few years. And usually the two or three big flavors that I'll say is you have a flavor about interest income to the private sector, basically saying, you raise interest rates, that raises the rate on government bonds, that means that the US government is paying more. You essentially created a fiscal impulse. This is very close to, if you've read, *Some Unpleasant Monetarist Arithmetic,* these famous papers about the fiscal theory of the price level, that's very closely related even though, academically, the people making that argument are closely related. Second argument is like, "Hey, the Fed raises rates. We know that that hits different parts of the economy.” People will say, "It hits supply more than it hits demand." People stop building homes, companies stop investing. What you actually do is you reduce the capacity of the economy to meet aggregate demand, which actually just makes inflation worse.
Politano: And the third argument, which is a very niche financial argument that you sometimes see is about bank margins. And this is something that... Because I'm very steeped in Fed speak, I have had to deal with this as well for a while, where you say, "Hey, you raised interest rates, that means banks can loan at a higher interest rate,” but banks nowadays don't really pay depositors more. If you have a checking account, you probably noticed you're not actually getting interest on that. So, it actually just means the banks make more money from lending money so they're going to lend more money, which is inflationary.
Politano: And so, starting with that last one, it's really funny because I think the last few months have been, basically, definitive proof that that's wrong, where if you asked bank managers they'll say, "Oh, yeah. We're raising margins. Also, we're lending less money." They agree monetary policy is tightened. They didn't have this galaxy brain thought about bank margins where they were like, "Actually if we lend more money we could actually make more money." Because you're tightening policy, you're raising risk fundamentally. And that's the big deal for most financial institutions, most financial intermediaries. The second one, I am somewhat sympathetic to, and there's some good papers that show the price puzzle, this idea that if you raise interest rates, sometimes inflation stays as high as it was or it increases for a little bit and then it comes back up. That price puzzle is related to mortgage rates and home ownership.
Politano: You raise interest rates, mortgage rates go up, people who are on the margin between buying and renting, they decide to rent, suddenly rent prices go up more than you expected. That feeds into higher inflation. That's pretty definitively like a, “Hey, supply hits… you're hitting supply more than demand." But that's, basically, the only sector that you can see that happening. And all of the other sectors of the economy put together, you see it hit demand more than it hits supply. And in housing it hits demand more than it hits supply too, it just takes a little bit longer. So, I think that is sympathetic, but I think that one's also wrong. The first argument about the interest income to the private sector, I've always found very weird because interest income is very small compared to fiscal spending in the United States, and the margin that you're moving on is very tiny, and public debt is very small compared to private debt in a lot of cases.
Politano: So, the net effect of the federal government is spending more to service its debt, sending that to the private sector, most of whom are very high income individuals with a low marginal propensity to consume, those are who bond holders are, and I don't see that causing a big inflationary impulse. And the big thing I would just say is we have these tools, like we mentioned earlier, to look at financial market expectations of inflation, they've gone down as rates have gone up. So, if there was this actually secret reverse way where raising interest rates made inflation worse, we would see that. I think people's intuitions here are important. It's good to think about this since they realize, "Hey, just because interest rates are higher doesn't necessarily mean that monetary policy is tighter."
Politano: Monetary policy is looser now than it was in 2008 when interest rates were zero and the economy was in free fall if you're evaluating based on inflation, based on real economic outcomes. But I think a lot of this is arguments from people who are more left-wing economists, who are worried about raising rates causing a recession and they want to argue against raising rates. And it becomes then a weird double push because internally you're saying raising rates might cause a recession, also it causes inflation where it's like, "Okay. If you genuinely believe that this was a positive push on aggregate demand, wouldn't you be like championing the Fed?"
We have these tools, like we mentioned earlier, to look at financial market expectations of inflation, they've gone down as rates have gone up. So, if there was this actually secret reverse way where raising interest rates made inflation worse, we would see that. I think people's intuitions here are important. It's good to think about this since they realize, "Hey, just because interest rates are higher doesn't necessarily mean that monetary policy is tighter."
Beckworth: That's a good observation.
Politano: Yes, please raise rates more.
Beckworth: Yeah. No, because you're right. Because as I think through the people who I have heard make this argument, they tend to be Post-Keynesians, more progressive. And you're right, they're really concerned the Fed’s overdoing it, understandably so given the rapid ascent of the rates. But they do often tend to be the people making the arguments that higher rates lead to higher interest income leads to higher spending. And that's a great point. I hadn't made that connection, Joey. So, it's great to chat with smart people like you who see that. But I think you're absolutely right. And the supply side story, I think, is an interesting one. I think it's valid, but as you said, quantitatively, it's just not that important. So, I know there's an economist from the San Francisco Fed, Adam Shapiro, who's done some research on this and he's engaged with me on Twitter. And he's shown… actually explained this price puzzle.
Beckworth: There is a supply side story, but it's not important enough, I think, quantitatively, to matter. And so, the only thing that's left is the fiscal impulse story that you mentioned, that fiscal policy is effectively injecting more money. And look, I do think it's understandable, people are talking about it, but given this scale of interest rate hikes. So, another individual that we were engaged with on Twitter mentioned that now his Treasury bill… He didn't spend any more money, he just rolled over his Treasury bill and the yields on that are much, much higher. And that those are dollars now being sent to him that weren't being sent before. Alternatively, if there's a bank earning interest at the Fed or a money market fund, they too are getting much higher rates and they could go spend that as well if they wanted to. But the key issue is, is that effect big enough, important enough? Markets don't seem to say so, and they seem convinced that at some point this is going to be offset or it's not just important enough down the road. So, very fascinating stuff and I'm glad you've touched on it. So, Joey, in the time we have left, let's talk about monetary policy more generally, what can it do in an economy, like the one we're in, where supply side constraints are in effect? I know you wrote an article on it, so maybe speak to us about that.
Monetary Policy in a Supply Constrained Economy
Politano: Yeah. So, this is actually a really interesting topic that I spent a lot of time thinking about. Because you look at the global economy over the last few years, and I think people have been complaining about supply chain, supply constraints more than possibly ever in modern history. And it constantly reminded me of the research of János Kornai, who's a Hungarian economist who passed away early in the pandemic. And he did a lot of research on market and planned economies. So, he was born in the Eastern Bloc, Soviet system and that's where he grew up. And he got to study economics. And then he also had the opportunity to study in the market economies in the west. And he got to watch the fall of the Soviet Union. And the big thing he talks about is, structurally, a lot of these Eastern Bloc economies were in constant shortage of materials, which is weird when you think about it because you should... Really, if it's a structural shortage, someone should just build more capacity at some point.
Politano: Why are you always missing things? Why are the shelves always empty? Why are companies always struggling to procure inputs or labor or whatever? He pins some of the blame on this, on the pricing system and administering of prices incorrectly. But at the same time, if you think the Soviets are just bad at pricing things, wouldn’t they set the prices too high sometimes when you have surpluses of random things? So, he comes down on this idea of talking about the soft budget constraint. This idea that when everybody has enough infinite demand or at least isn't constrained aggressively by demand, they just start snapping up things. They snap up inputs to hoard, labor to hoard, supplies, consumer goods. And now, perpetually, there's nothing here. And it was really remarkable because I talked about those surveys earlier of why they'll ask factory managers, why can't you produce more?
Politano: And it was always funny because in all of these Western countries when they did these surveys, the fact the managers always answered, “because people wouldn't buy it.” And in the Eastern Bloc they always answered, "I don't have enough workers. I don't have enough inputs. I don't have enough of these things that I need to make the things that people buy. I know people will buy them if I could just find the things that I need." And then it was remarkable to watch in the early part of the pandemic, and especially over the last few years, all of these surveys in major market economies looking like the surveys in the Soviet era planned economies. All of these people saying, "I can't get inputs. I can't get labor. I'm struggling tremendously." And I think that that was a signal to me where it's like, okay, if some people are struggling with inputs, some people can't find things.
Politano: If car manufacturers can't find semiconductors, that's an isolated problem. If everybody is struggling to find inputs, that's a system-wide problem. And so, you think about that distinction quote I made where you said where the Soviet economies had this soft budget constraint. Firms, functionally, they couldn't go bankrupt, they couldn't fold, they didn't have to be profitable. So, they were just grabbing as much as they wanted, knowing that they were technically subsidized by the state. And the firms in market economies were very demand constrained. They had to be profitable. They didn't get money from the state. So, the only way that they're going to make money, they're selling things to consumers. So, they have to plan for this idea of, “People have to buy our stuff if we make it for us to make any money.” I think that binary is important. But I think what we're learning is it's more of a spectrum.
Politano: And over the last few years as a global economy, we've been really close to, the budget constraint is too soft. Companies feel like they have infinite access to money or at least too much access to money. And that is resulting in these very widespread shortages because when you're not constrained by demand, you become constrained by supply. And I think we're watching central banks reinstitute a lot of those demand constraints now. That's what tighter monetary policy means in one sense of the word. And you're seeing a lot of the supply improvements. I think you can attribute that to a lot of genuine capacity building, a lot of genuine improvements in supply chains. But I think some of that should be attributed to the fact that demand has gone down. It's becoming more constrained as monetary policy tightens. I think the big question, I'm sure I'm not the first one to say this is the big question, over the next couple of years is, can you get back to a normal-ish demand environment, a normal nominal demand environment without a recession?
Companies feel like they have infinite access to money or at least too much access to money. And that is resulting in these very widespread shortages because when you're not constrained by demand, you become constrained by supply. And I think we're watching central banks reinstitute a lot of those demand constraints now. That's what tighter monetary policy means in one sense of the word.
Politano: I think I've become much more optimistic over the last eight months. Like I said, it's maybe closer to 48% to a coin flip chance as compared to what it looked like earlier where it was very bad, most likely going to have a recession. But I think what we're learning in a lot of senses is about how broad the impacts of monetary policy can be and how they can touch everything, and how even things that, in my mind, that didn't look to be related to what the Fed was doing, may have actually been more related than I thought.
Beckworth: Very interesting. So, the Fed is adapting to the new structure of the economy and in adjusting demand, in this case, dialing it back a little bit so that it meets the new capacity constraints. So, it has to be nimble in that regard and that’s not always easy when you have something as big and as shocking as the pandemic, but very fascinating. And, Joey, with that, our time is up. Our guest today has been Joey Politano. Joey, thank you so much for coming on the show.
Politano: Thank you so much for having me on. It's been an honor.
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