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March 7, 2024

2024 Or Bust: The Economy, The Fed, And Fiscal Policy


Claudia Sahm photo
Claudia Sahm | Founder, Sahm Consulting

How will the US economy perform in 2024? 

Claudia Sahm (Sahm Consulting) joins Richard K. Green (USC Lusk Center for Real Estate) to discuss the US economy’s recovery from COVID alongside additional shocks and infer the implications of the Federal Reserve’s playbook for 2024. 

Sahm’s key points:

  • The US economy undeniably turned a corner in 2023
  • The US recovery remains stronger than its peer countries
  • The Federal Reserve will continue its conservative approach to rate cuts
  • The greatest risk to the market in the near future is the Federal Reserve’s sluggish response

Sahm also fields questions on the risk that commercial real estate and regional bank distress poses to the economy, the Federal Reserve’s limits on impacting housing affordability, and more.

Listen via podcast


- My name is Richard Green. I am Director of the USC Lusk Center for Real Estate. And as of last week, a non-resident fellow with the Urban Institute. And it's my pleasure to welcome you to the March, 2024 edition of Lusk Perspectives. And we have a returning guest today who has been a popular guest in our previous Lusk Perspectives, Claudia Sahm. Claudia's a very well-known macroeconomist who is particularly known for the Sahm Rule, which is the way one predicts recessions. And because I suspect the Sahm Rule said we were not having a recession, she, unlike about 90% of the macroeconomist world, did not think we would go into a recession. And of course, she's proven to be right. I would like to call your attention to her very cleverly named Substack, which is Stay At Home Macro, which turns into SAHM for Sahm. And I'm just gonna read from how she describes herself. She says her goal is to bring the best economic policy and macroeconomics to you. She covers a wide range of topics from inflation, to jobs, to child tax credits, and all things Fed. She's the Founder of Sahm Consulting and has worked at the Federal Reserve and at the White House that advised Congress. And I'm proud to say when she was working at the White House, I got to work with her when I was at HUD, and it's always good to see her. So Claudia, thanks so much for being with us. Claudia, please take it away.

- Great, thank you so much. I really appreciate being here again. And yes, Richard, it's always awesome to see you. All right, so what I'm gonna do today is talk about what's happening in the economy, the Fed, fiscal, both where we're at and where we're potentially headed. And you know, I like to just lay it out there and be provocative. So this, it's 2024 or Bust, right? We are very close to getting to the other side of this, and yet we are not there yet. So this is a very important year, kind of pivotal in where we are with the economy. Okay, so just to start with the key takeaways, I'm gonna go through all these in more detail. The US economy turned the corner in 2023. As Richard noted, I, for the better part of two years was well out of consensus saying that we did not, that we were not in a recession, the recession was not imminent, and we certainly did not need one. And those were all three swirling around the consensus of my peers. And I, you know, there was a story to it that I had that COVID was very disruptive. Putin invading Ukraine was very disruptive. And that we would work out those disruptions that would get inflation down. We had a strong labor market. Consumers were spending, it was just gonna take time. It took far longer than I had expected to work through the COVID disruptions, but in 2023 it was clear as unemployment stayed below 4%, we had very strong growth, big disinflation, right? So this was the thing that wasn't supposed to happen according to the other 90%, but it did. All that said, we are not out of the woods yet. And things will be bumpy. And I'm gonna show you some bumpy data that we got just last month. Okay, so one another piece that is worth understanding is the US recovery has been very strong relative to our peer countries. I'll go through a few examples of ones in a bit. Now there were different approaches to fiscal policy, particularly as we came into 2021, the US did one more big push with the rescue plan and then we did three big investment packages. Nobody else did that. And yet there are also big structural differences between our countries, even before COVID, that are likely playing a role now too. Of course there'll be a good bit here on the Fed. And anyone who's listened at all kind of following the headlines, Fed Chair Jay Powell has been in Congress the last two days, actually, I think he's probably still got another hour or so to go answering questions. And the Fed is going to be very cautious. They're going to be very measured. I will go through this in a lot more detail, but they're waiting. They're gonna wait longer than they need to. And yet I think in the sense that inflation is coming down fast, and yet I think we're still gonna be okay. We've got some padding, there's some margin for error on the Fed's part. So I'm pretty far out in terms of their first cut, which is I think late July, maybe June. But just listening to them, I think they're more in line with July now. And if you ask me what I would do, I would say start gradually cutting now. So there's a lot of daylight between what I think they'll do and what I think they should do, you know? Okay, biggest risk, I mean the biggest risk, the economy is the Fed this year. There are other, in the running Congress, the election year, those are potential risks. It's a little harder to see how they go straight into the economy this year. It's probably a bigger deal for democracy and social cohesion. But the economy is a big part of the picture. So again, there are risks and we should take them seriously. Okay, so now to give you some of the data to back up what I just said. So we're headed in the right direction finally, right? Inflation, which has been the real problem starting in mid 2021 and particularly in 2022 is coming down. Now you can look at any kind of inflation measure and see this pattern. What I'm showing you here is something that the Fed pays a lot of attention to. Core, so excluding food and energy of the Personal Consumption Expenditure Index. So PCE inflation, that is where their target is defined, is in PCE, not CPI. And their target is in total PCE inflation, and yet core gives us a better sense of where inflation is headed, 'cause like energy and food, things bounce around. And the Fed's goal is to get inflation to 2% and have it kind of stay there, right? They don't wanna just hit two and bounce off, right, so, or keep going down. So, but you can see here on any time horizon, there's been an immense amount of progress since particularly the middle of last year. Yeah, this is good. And yet January that we got the data, we always get the data about a month afterwards. When we got the CPI, PPI, PCE, like the whole board of them of inflation, they didn't look so great in January. There's a lot of potentially wonky stuff going on under the hood. In fact, right now as we speak, the Bureau of Labor Statistics is doing a webinar on one piece of it, which is related to owner's equivalent rent. So there's a lot going on in January, but it all went in the wrong direction. So inflation popped up, and you can see this in that green line, the three month average. So this is like the latest data. That one has been much more volatile, bumps up and down each month can, you know, surprise us one way or the other. And yet we've made steady progress down and towards the target. So we're going to 2%, and we could really get there this year. That's my baseline. Okay, so there's inflation. And yet at the end of the day, I mean price tags, higher price tags are hardship for many people and they're annoying for everybody. This is clear from everyone sharing their receipts online. But what's really important at the end of the day is can you go home from the store having paid for and get the things that you needed, right? And so what I'm showing you here is consumer spending. This is aggregate, is for all households and it's taking out inflation. So real PCE, this is inflation adjusted. And if you look at that, we are right back on trend, right? That's a very impressive, and that means people are getting stuff. Now, there's a lot of inequality under that and some people really are having a hard time. And yet there's a lot of progress that we've made. And if you look after the great recession, that was not the case. We did not bounce back that quickly. There are different recessions, but still, it's something to celebrate. And then the biggie is on the right. The unemployment rate is, I mean, it's been below 4% for two years. You have to go back to the 1960s to find a longer period. And frankly, our labor market is better than the 1960s because it is much more inclusive. We had women's, prime aged women's employment rates hit an all time high last year. Black men's labor force participation hit an all time high. We have more people, workers with disabilities out there with jobs. So you just, you name it, we brought people from the sidelines. And that's like the unemployment rate is a sign of how good it is. That's actually what the Sahm Rule is based on, is the unemployment rate, changes in it. And yet it's telling us about all kinds of benefits, increases in wages, paychecks, better jobs. I mean the labor market's the real success story, and the way it works in the US economy is for many Americans, their paycheck is what they have to spend. So if they have good paychecks, they'll spend it. And so you get in this virtuous cycle of the American consumer and the American worker. And that's our padding, right? That is the margin of error for the Fed. Now I have a take a lot of issue with them kind of rolling the dice on the American worker and consumers, but this is, like we're in a really good place here and this is what we have to protect. And this was also when, for two years I was told the recession was coming. I'm like, are you looking at this world, right? Like the labor market was just way too good to be in a recession. And thankfully we are not and we need to stay out of one. Okay, so then we talk about the soft landing. So my definition of that is inflation gets back down to 2% and the unemployment rate stays low, like under 4%, 4% ish or under. Okay, so that's what we're headed towards this year. That is my baseline. There are risks around it, more about that in a minute. And yet the other thing that is happening, and we just got more information on this today, productivity growth has been good in like the last, not quite the last year, but in the last several quarters. And like this is the holy grail of economic prosperity is to get even a little bit more productivity growth, because over time it really adds up. You know, it's really hard to measure productivity and it can show up and then disappear on us. And you'll see these are quarterly numbers, and they kind of bounce around. But we've had a got a good run going here. And I think a good argument is a full employment economy, like I said, these people coming off the sidelines, some of whom had barriers to being at work and yet were highly productive people. So we're getting them in and their absolutely technologies underway, the work from home, the ability to do a talk like this today remotely and bring in a lot of people, and hopefully we're learning something from each other, like that's already here and is clearly part of that full employment economy. And you know, there's, we hear all the amazing things that artificial intelligence is doing and is going to do, even if it's overhyped to some degree, it certainly has, it has a lot of potential to show up. And it may take a long time to see it in the productivity data, but it's really more about like the productivity reality, right? Like be able to do more with less, 'cause it frees up time to do other stuff. Okay, so that's very encouraging. Switching to a less encouraging note. So it's always important to think about the risks, what could go wrong? So as someone who thinks a lot about the macroeconomic outlook, I always build a baseline, like what I was just giving you, drawing off of data and research and all of that. And then it's really important to spend time on, well how could I be wrong? The best way to learn that is to listen to and watch people, smart people who think something totally different than you do about the economy. So I go find these people, it's not always fun, but it's really important. Two signs of stress that I am definitely keeping an eye on, and this relates very much to that virtuous cycle that I talked about before, is we are starting to see signs of consumers struggling with the higher interest rates, right? And what I'm showing you on the left is from the New York Federal Reserve Bank and its delinquency rates. So these are people going, transitioning into delinquency, and you see it by different loan types. And it is notable that for both auto loans and credit cards, they've been increasing for some time. You know, kind of like as the Fed started increasing interest rates. And they have now surpassed their pre-pandemic levels. Now they had fallen during the pandemic, which has a lot to do with the big fiscal relief. And yet they're still climbing, right? And this, now interest rates are much higher than before the pandemic. So one should expect, I think, to see delinquency rates higher than before. But that's not a good sign, right? And again, anything that really knocks the consumer off will have an effect in the labor market. The second chart is, and what I'm watching most carefully right now, are any signs of stress in the labor market really taking hold. And one that has gotten attention is the hiring rate. And this is from the job openings and labor turnover survey. So these numbers are through January, and what you can see is over the past several months, I mean this is, or since 2022, so this is like a longstanding, as we've gotten out of the labor shortage, as we've seen this hiring rate come down quite a bit. And now it has drifted below, again, pre-pandemic, remembering before the pandemic, that was a really good expansion. So it's nothing, like this is not red alert right now, and but the firing rate has stayed low. So there's some interesting dynamics going on in the labor market. So far on balance, it's in a good place, but that's not, you know, that's with the labor market and job stays tomorrow, is often by the time you can really see the problems are there, it's too late, 'cause the labor market does kind of move slowly. So that's why we pick apart all these little bits and pieces under the hood, because by the time it shows up in the unemployment rate, it's really, the momentum is already there. So we'll see, so far so good. Labor market totally is the success story of this recovery.

- Could I ask a quick question about the new employment rate as a share of total employment? Could it be, I mean, so many people change jobs for a while, and we saw that in data too that people just got tired of doing it and are just content to stay put for a while. Couldn't it be as much a supply side phenomenon as a demand side phenomenon?

- It could be. The other, I don't show it here, but the quit rate, I mean that's very much like the supply side of that. Like the workers actually quitting, so it has come down a lot. I think it might be at, it is like right around this pre-pandemic level. Now it could be like just fatigue, like you can only, you know, move to so many jobs. But I will say like you can see in like the Atlanta Feds Wage Tracker data, the people who switched jobs, and this is not just now, but the people who switch jobs, they're the ones that get the big pay bumps, right? And so there's a big incentive to move to a different job. I think typically the quit rate is high when jobs are plentiful. And yet I don't, like I said, I wouldn't look at these as, you know, red alerts, and we did the labor shortages were not a sustainable place for businesses or consumers or workers. I mean, you had a lot of people putting in extra hours that it wasn't entirely clear if they wanted to work the extra hours. So we had to get out of that. We had to get to something more, quote unquote, normal. It's just the path back to normal is a, can be a really tricky one, because it's fine if these trends start to level out. If they keep getting worse, then that's the, you know, so we need to like get, that's the whole thing, like with the soft landing. And we see that kind of everywhere, this moderation, is you really gotta like kind of stick that landing. And it's just not something the 25 plus trillion dollar economy is good at doing.

- So I think there are a couple of questions from the audience that would fit in well now, given what you're talking about, and they kind of go together. An anonymous attendee says, how do you anticipate the impact of AI on the employment rate that you have shared? And then Evan Perlman, similar question, given the transformative impact of technology on the modern labor market, which enables individuals to generate income outside of traditional employment frameworks, thereby potentially reducing the number of people classified as unemployed, do you believe it is necessary to reevaluate the metrics by which we compare historic unemployment rates to contemporary ones?

- Yeah, so working backwards, measurement is always challenging, right? And I think we've already have a very discussion about the informal work arrangements that we have now, how well they're captured. The official statistics on employment were designed at a time where you had a single breadwinner and he worked a 40 hour week, right? And so the types of questions, and we need to have consistent questions over time. They're really mostly designed for that and for people that work in informal sector, which has been with us always, like the gig economy has been here since day one. We just have technologies that kind of have changed the way we do it, and you're self-employed or how you report it. So we already know that when a technology or just kind of a shift in how work is done happens, our statistics can get really tricky to capture that. And I, yeah, so that'll be, now the benefit is, like that's the kind of question, and absolutely with AI, like thinking about other ways to measure it, right? Like it won't happen in the official statistics to start with because we try to keep those a very consistent over time, and yet this will show up other places. And I even have had people who work in artificial intelligence places, kind of working with the technology who are really interested in coming up with metrics to track its effects on the labor market. So yeah, like we can't rest on our laurels with any one piece of data. The Sahm Rule uses the unemployment rate, which is a pretty, well, it's a really broad brush, mainly because it was designed to be part of a policy proposal of automatic stabilizers. Like I needed something that was very accurate and yet also very transparent. Anyone who's really trying to sift through what's going on in the labor market would never stop with one statistic, one piece of data. On this bigger question, and these do fit together. On the bigger question of how would artificial intelligence affect like the labor force, affect workers? So I mean, no, like, this is a very, this is like a new question, frankly, or new in a lot of prominence, AI is not brand new. But what the specific use cases will be extremely important in how it affects people. We have a lot of other transitions going on in the workforce, so it's not that AI is a standalone, and to underscore how much things are up in the air, I would recommend there are two kind of competing papers from extremely smart economists. So David Otter and Drone Asomobu both have papers out. Well, I think Asomobu is with co-authors, kind of thinking through the pros and the cons of AI on workers, and they do take, David is much more optimistic and Drone is more pessimistic. I tend to be of the case that, you know, we've had technologies come into the workforce and affect workers for generations and generations. And largely the transition can be very painful, particularly for the workers directly affected. And yet on the other side of it, we have benefited from, you know, automating out jobs that really are not good jobs and kind of pushing us to a better place. But that's a huge question, and yeah, I'd like to know the answer too. So, but it's gonna take, and it'll take, to the second question, it's gonna take a lot of really careful measurement and trying to do it in a comprehensive way, like get past just anecdotes in one company here and there. We good?

- [Richard] Yes.

- All right, all right. So briefly I want to set what I've told you about the United States in the context of our peers around the world. Okay, so the US is special, and this is actually in a good way. So we are the clear leader in this recovery, and this, you know, I'm sure this is the United States, we're kind of anchoring at right before COVID, and then looking at inflation adjusted GDP. So this has taken out the inflation, and that dark blue line is the United States. And we were on a better trend going into COVID, and that's actually will show up in the next slide. And yet, like this is, especially in the last few years, like we are absolutely pulling away. And frankly, with some, well, the best case would be that everybody's right there with us, right? That the, you know, I've talked a lot about how the economy is really strong in the United States, the recovery, this is good on so many dimensions. What is going on in several countries, you can pick out Germany or the UK as two examples. Like it's really sad, right? Like this is not, like they are in a tough place. And the twin of this one, so I'm showing you real GDP, if you look at productivity across countries, again, we are just knocking it out of the park, which you know, is tough for our peer countries that aren't. A big question that is, you know, swirling around is why is this, like what happened? I mean, we are generally, the United States is different in a lot of ways, its economy and its policy space. But you know, this is given the fact that we all had the global pandemic, we all had Russia invading Ukraine, two very disruptive events in the economies. But the United States, part of this is almost certainly the fact that the United States did a bigger fiscal push. Nobody else had the American rescue plan, nobody else had three big investment packages. So that's clearly what's in there. And it looks like with productivity, this is some staying power. This isn't just the US government pumping up our GDP, you know, indefinitely. The, you know, part of the stimulus and just other reasons the consumers have been more resilient, people have been able to put money in the bank. We've got higher productivity growth. It's possible that we, I mean this is a fact, but it's not clear how big this effect is. The United States is potentially less interest rate sensitive. We're the only, well not the only, but the United States mortgages tend to be on a much longer term than other countries. And so then the interest rates went up very quickly. And in the US, you know, actually the bulk of homeowners in the United States refinanced. Mortgage rates of what people are actually paying have trended down this whole time. Credit card rates, not so much, they absolutely went up. But in other countries, they have shorter terms on their mortgages, and so you get more of this resetting, and the higher rates have been hitting other countries harder. And then absolutely there were differences in energy price sensitivity--

- So I just wanna, yeah, Claudia, let me just say, so in Germany, it's actually, they have long-term fixed rate mortgages too, but you can't refinance out of 'em. There's a large--

- Oh okay.

- Repayment penalty. So there, I think it's the opposite. They couldn't take advantage of the low--

- Yeah.

- Customers couldn't take advantage of the low interest rate environment there the way they could here. And so it is sort of the negative of what you think of in terms.

- That's a good impact.

- But I just wanna throw that in there.

- Yeah, no, and am I right, is the UK and Canada are two that have--

- Yeah, they have short term rates, yeah.

- I didn't know that about Germany, that's interesting.

- Yeah, no, I mean the UK it's all basically one year.

- Okay. And in Canada, three years is kind of typical. The other thing in Canada is you have to refinance your mortgage every five years. So it's sort of like commercial loans in the US.

- Oh wow.

- So that puts pressure on Canada in a way that you don't see. In the UK, you get to keep your mortgage, just rates have gone up. And you know, I've thought about it, I've thought the reason the UK has done so badly is largely Brexit, but now that you bring it up there, the way their mortgage rates work probably has something to do with it too.

- Yeah, well and it does underscore, I mean now I learned something about German mortgages, like these cross country comparisons are so hard to do because there's all of their important structural differences. You know, the example with energy price sensitivity, I mean Germany was very dependent on Russia for its natural gas. Like that was a choice they had made be well before COVID. And so while, you know, in the United States we paid $5 a gallon gas nationally, but we got past it, like Germany is still dealing with these issues, which brings me, this very much dovetails with structural weaknesses before COVID playing a role. And so, you know, the quote down there in the left, this is, I mean it's the Brexit, right? Like this came, there was a study that came out today from one of their budget kind of watchdogs that it looks like those forecasts that had been made by like the Bank of England economists before Brexit that were so dire, like they're kind of on track for this, you know? So, now there's certainly been pushback that these, you know, from pro Brexit people that these studies now are too pessimistic because it's hard to disentangle. COVID happened, we're trying to work our way out of COVID, or it has done the damage and now we can't get back on track because of a structural problem. There are absolutely examples in the United States where problems we went into COVID with, COVID blew them up. And the discussion around affordable housing I think absolutely fits into that. We put a lot of stress on the housing supply because people were moving around, and people were able to start families that, you know, they had some money, jobs were good, it shouldn't all fall apart when people want a home. But we went into this with an underbuild of housing and so like it made that problem worse. Hopefully that will be the call to fix the problem. But I mean that's structural weaknesses are there because they've been hard to figure out. So like I said, you've got the UK with Brexit, Germany, I mean one of the fallouts of these, the energy issues and the way they were handling some of it is it seems to be worsening, maybe setting them on a path for really undermining their industrial base. I mean that's Germany's kind of the engine and it's manufacturing and it's exporting. And for a lot of reasons, not just the natural gas, also China's been a weak economy, like they're really taking it on the chin and that's a pretty fundamental part of their economy. And I've, France in here too more is an example of a policy framework that is used in Europe. So these are fiscal rules. So they set, not necessarily limits, but I mean kind of guidelines. And in some countries like Germany, they are pretty tough about following them. That your deficit spend, you can only do deficit spending to a certain percent of GDP, right? They have targets. Now in crisis like during the pandemic, you know, the early recovery, the European Union eased those and said, no, no, no, it's okay, it's an emergency. You need to spend what you spend. Now they're back in a period of, I know you, you really, there are limits on spending. A recent, in France came out recently that they had to do, are going to do cuts in their budget, not raise taxes, but cuts in their budget because their growth forecasts were too optimistic, right? So I showed you this like weak growth in a lot of European countries. So it's actually the case that like, because their growth is slow, they're going to have to cut back on their spending, which is kind of the exact opposite thing you would wanna do when your growth is slow. So that's just a case. And Germany's High Court said they couldn't reallocate funds to do climate spending because of fiscal rules. So there's like some policy decisions that can kind of tie your hands. And so again, that pattern we saw for Europe, like doing not as well. Like that's probably not gonna change anytime soon unless they're dealing with these structural problems. Okay, that was really a downer. Okay, so, but again, I mean the silver lining from all of this is COVID did, and also Putin shine a bright light on the problems that were in economies, and they differed to some extent, and it's an opportunity, 'cause people are really fired up about it. It's an opportunity to do something. Okay, so the Fed, and I am being a little snarky with the subtitle here, but they've talked endlessly about wanting to be confident about inflation, so they deserve. Okay, so what I've got here are, well this top one, so the Fed Chair always speaks for the Fed, right? So it's very rare that Jay Powell would be out just, well I think X, Y, Z about the economy, right? He is a mouthpiece. Like if you want to understand anything about what the Fed is thinking or potentially going to do, listen to Powell, right? Like the rest, you'll hear every day. I mean those of you who you know follow the business news, I mean every day there's like multiple Fed officials running around on TV giving speeches. I mean it's just, it's an overload. Powell does not speak very often when he speaks, if you wanna understand the Fed, you should listen. And honestly for the most of the rest of them you can ignore them. Although voting members I kind of pay attention to. Okay, so this is the, he has repeated this multiple times now both on 60 Minutes and on the Hill, you know, they want to see more good data. You know, they got six months of good data on that PCE core last year. He acknowledges that, they want more. Now a piece that was important, and I think he and other Fed officials have tried to underscore this since the January inflation data, is not every month is going to be a good month or as good as the last six months. Like it just needs to be good. And if you like squinted the January data and take into account all the weird stuff that was probably going on, it'll probably be good enough. And I think that's what comes out of, everybody's waiting to see the February data next week. But I think that's, the Fed has gone very data-driven. I think it's become hard for markets to parse it because the Fed doesn't overreact every data point unfortunately by saying it's so data-driven, it does encourage that behavior from others. So a widely expressed sentiment from the officials is they have the luxury of time to become confident about inflation. And that's because the labor market is strong, growth is strong. So, you know, I firmly disagree with this thinking. I don't think that the US worker and consumer should be their security blanket for them to get confident to just even start gradually cutting. And yet this is like, for me, I look at the strength in the economy and that's the margin of error for the Fed to me to watch them grab the margin of error and like hang onto it is just, it's hard. But whatever, I mean they are being relatively clear about what they're thinking. So they are, but they are starting to talk about the other side of their mandate, right? Unemployment's been very low and inflation was high. So it was clear they needed to get inflation down. Now as inflation has come down, they're like, okay there are risks of waiting too long to cut and harming the labor market. So they're finally starting to talk about here, this moving into better balance, the risks. Now where we should be in the end is the risks are balanced. We're not quite there yet. They're still more focused on inflation. But this was actually a big deal to hear them start shifting at the end of last year. And then there's Atlanta Fed President Bostic, who has definitely distinguished himself as one of the hawks particularly, and he's voting this year. He does the other thing that I find very disturbing from the Fed, though I understand it, making the argument the worst possible outcome is that the Fed begins to cut and then has to raise. I mean this makes no sense. I mean policy adjustments happen all the time. It's not ideal. You know, the world can change, you get surprised, but the Fed is convinced itself that the worst possible thing, not a recession, but the worst possible thing is have to cut an increase. So whatever, but again, they're very clear about it. So last thing on the Fed, why is the Fed doing this? Well, I've like for people that really want to understand the Fed, what they're going to do this year, what they're likely to do. And this is absolutely a cottage industry right now. Like when do you think the first cut is? When do you, how much will they cut and blah blah blah. To me this year has, so it has many parallels to the 1970s. It doesn't really, but I mean when you think, to understand the Fed, you have to think of the way the Fed thinks. Like how does the fed see the world? Okay, so the 1970s, and everybody on the FOMC was either like an adult or like, you know, old enough to kind of know what was going on. It was a period of high inflation. Arthur Burns multiple times cut interest rates. What then proved to be too soon, inflation came roaring back. So nobody wants to be Arthur Burns, nobody wants to cut too soon. That's where Bostic's the worst possible outcome comes from because that's what Burns did. The other thing that is really unfortunate that it lines up is Burns cut to help Nixon's reelection. And the Nixon tape showed later that it was like explicit. Like it wasn't just, oh, it looked like it when the Fed- No, like he agreed to do it for Nixon. And yeah, we got an election year, right? And there's a lot of politics. I have, the Fed will not put a thumb on the scale. Jay will not put a thumb on the scale. They'll get blamed for it. We won't be able to tell. But it does add another level of caution. And what it appears the Fed is doing, and this is why it's hyper data-driven, is it wants the data to tell the world it's time to cut, right? For it to be so painfully obvious that inflation is going to too. And that's not the way that you're supposed to do monetary policy 'cause it like works going forward. But whatever, I mean the Fed is what it is--

- So I wanna ask a specific question about that, because as it happens on the Atlanta Fed's website, they have a Taylor Rule widget. So the Fed that Raphael runs, they have a widget that says, what does the Taylor Rule say? And right now the Taylor Rule says that the federal funds rate is about 100 basis points higher than it should be. And so if that's not the data telling you what to do, what is the data telling you? What kind of data is telling you what you need to do? Because when I saw those lines cross, I thought, okay, they're gonna cut, now they've crossed like quite a lot. So anyway, any thoughts on that?

- Yeah, it's all PCE core inflation. That's it. I mean they want it to be a two, they're not, and it's a long stand- Taylor Rules were always inside the Fed. I mean John Taylor thinks they should decide monetary policy, but inside the Fed, Taylor Rules and similar policy rules are something the Fed looks at, right? They are a guide. And yet the Fed has never committed to rule-based monetary policy in that like looking at a Taylor Rule and doing X. So, you know, they did keep rates a lot lower than the Taylor Rule early in the COVID recovery.

- [Richard] They did, yes.

- And I still think there were, I don't look at what they did as a mistake to the same extent that others did. Like the world did some, you know, COVID kept coming back and there was, you know, Ukraine and all this stuff. But they, you know, and you can look over time in general they have deviated, right? So, but yes it is. I have a hard time because it's increasingly difficult to square the FMOC's thinking with any kind of textbook, how you think about monetary policy. And this whole, I was critical this morning online of Neel Kashkari talking about the Federal Reserve President of Minneapolis being like, well you know, the economy's great. What's the rush, all this. And it's like, no, no, see, we're forward looking, you know, so, but they've, it's really like 2% inflation. That's it.

- And at that, and because you just said, I wanna bring in one of our audience questions, from Keyorou, I hope I got that right. Asks what is the Fed's view, and really I wanna know your view on a potential bank crisis. And he's asking in the context of the CRE market being troubled. But what I've been worried about for some time is the balance sheet risk issue is you do have some banks with a lot of long maturity assets and if you mark them to market, they would be underwater right now because they don't have to march to market. They appear to be okay. Is the Fed playing with fire in the banking sector by keeping rates where they are for as long as they are?

- Yeah, so it's a nice transition to my last piece. So about the risk to the economy, the Fed, the Fed, the Fed, I mean, you know, there are some others but they are so squarely, and I think to your point, there's many different directions it could go. All right, so, well I'm like this is one specific, but more in general, to me, the Fed is the risk to the soft landing. So avoiding a recession, getting inflation down. And it could work through the economy. Like you could see it in the labor market, hiring slows down, blah, blah, blah, all that. To me, the more plausible case, and I think frankly this is more in line with a Fed caused recession in the past, is they break something in financial markets, right? There's a saying, the Fed goes until it breaks something. I think in this case it would be the Fed holds until it breaks something. Now it has to be, you know, they contributed to the Silicon Valley Bank failure, right? By raising interest rates from zero to 500 within a year unexpectedly, I mean that's not their fault. Like we, you know that because they went so big so fast, so unexpectedly, Silicon Valley Bank had been doing bad management practices. Like they clearly were not a well-run bank, but you put them inside of an interest rate kind of sensitive environment, like things had really gotten turned upside down. It has a lot of parallels to what happened with the guilt crisis too. It's like you had these, you know, when you talk about the banks with the balance sheets, right? Like even well run financial institutions, that depending on kind of their bread and butter, that kind of a change in interest rates is not something that they were fully hedged against. I mean most of 'em were like, well hedge, you know, I mean they're not failing left and right but you were in an environment and the Fed helped create this environment that basically punishes stupid. And that with Silicon Valley Bank to the Fed's credit. And the only thing you give them credit for here is they got it under control really quickly. So if the Fed breaks something or just something breaks in financial markets, doesn't have to be the Fed's fault. If something breaks in financial markets and the Fed can't get it under control quickly, then that's how you have a big disruption in financial markets and then it shows up in the economy. I don't know, like I've talked to a lot of different experts on commercial real estate, and some of them are pessimistic, like that it could be one of the ones to break. I mean not just these one-off like the New York Bank that now got bought by Mnuchin.

- [Richard] New York Community Bank, yeah.

- Yeah no, the New York, I was just, the whole constellation of Mnuchin and auditing, like that was just wild yesterday. You know, you could have these one-offs, and I think at this point bank supervisors, bank rating agencies are really onto the idea that like CRE could be a big problem. So they're going in and carefully going through like banks and figuring out where the problems are. So it's often when something blows up, it's something we weren't really paying attention to or wasn't very transparent, like the private credit market, private debt, you know? I mean like, so there are some things out there that could come to get us. I think another piece of the environment, you know, we've had these interest rates went up, but I think there's some kind of getting used to it or we're aware of like where these pressure points are. The one thing the Fed is doing that makes me very nervous is their communication. There's so much interest in this, like when do they cut? And you know, things have been all over the map in terms of market expectations, and I don't think, I think the Fed is, well yeah, I mean their communication policy, that's their fault if they get screwed up 'cause it's what they said. But they've gone to this extreme data-driven approach. They haven't given markets the tools, and you can't teach these on the fly, but they haven't given the tools to really read the data the way the Fed does. So you had a week, it was such a bad week, where we got the CPI on Monday, it was bad. So all the like Fed probability shifted out for the first cut in the markets. Then retail sales was bad, so then they kind of moved back the other way because the Fed would have to cut if there's a recession. And then the PPI was crap. And so then it moved, you know, back out. And I was at event with Mary Daly was speaking after the PPI came out and she's like, you know, my views on inflation didn't change at all this week. Because like, they look through all this, but markets are like all over the place. Volatility creates stress, stress can go bad places. So my baseline is like this doesn't matter, like big picture for the economy, there still could be banks or institutions that get into trouble, but it's a real risk. And the longer the Fed drags its heels, the more the risk is there, so.

- Okay, couple of questions from the audience of the night. If we have time, I have a few of my own. But from Scott Laurie, assuming there is no quick fix to the US housing supply, are current record high prices the new normal for the near future, or do you see a potential decline in prices due to the complete lack of affordability and high interest rates?

- We're getting relief on the increases in prices. So if you think of shelter inflation, and we do know that some of the spot rents, at least on the rental side have in some community, even started to decline. So there there could be some relief on the prices for the rentals. I mean the housing prices will continue to go up. We don't have a good inventory. I mean this in addition to the fact there was an underbuild before COVID, then you had this lock in because people have these low interest rates and they don't wanna sell. And so now, and then we had the demographics that were gonna make this worse anyway. So like there's just all kinds of things in the housing market that frankly it's a little weird the way it's reflected in the inflation numbers, right? Like the way shelter inflation is done is not totally what people deal with every week when they're trying to either buy a home, or pay their mortgage, or. So yeah, there are no quick fixes in the housing market. My goodness, I like pass it over to Richard to talk for four hours, and yet it's like, this is a real problem. Like, and it's a problem not just for people, it's a problem for the, you know, a dynamic economy, and yeah. And you know, the administration, I think they put out a fact sheet in the state of the union will come out, and they're trying to make another big push on various kinds of housing policies. You know, some I think that are useful and some that are not, that sound good, but you know, you just gotta, they gotta build, you know, and so it's subsidizing. And then the big problem is at the state and local level too. Like it has to, it's a big problem. So it has to be a big solution. And I just, I don't see, I mean, I don't know. It'll be interesting if this moves the needle, but when, any interview about inflation or any discussion where I say, hey, the US economy is doing great, I am overwhelmed with, but you know, the housing costs of this. It is like, I get it, but I'm not hearing a lot of like, and we're gonna fix it. Like we're committed to fixing it. Like, so yeah, the price, I don't see any relief on the prices. And frankly, and I will say the other thing is, you know, 'cause this has come up in inflation because as we continue to get the CPIs, a huge chunk of it is shelter inflation. The Fed cannot fix that. I mean they can, they can get that inflation down by destroying enough demand and having people move back in with their parents. But like it's not a long-term solution. And frankly, high interest rates discourage building, right? So this one, the Fed cannot fix.

- I gotta tell you, I was at a conference watch where I saw two guys arguing over how to measure the cost of housing for owner occupants. And one was on what's called the user cost side, and the other was on the owner's equivalent rent side. And a fist fight nearly broke out. And they were yelling and screaming at each other. It was really something to behold. So this is what gets economists lathered up is how to measure this stuff.

- Yep.

- From Chris Shade, and I hope I got that right. Do you think the Fed's overly cautious approach is due to their feeling that Fed credibility was damaged by the inflation's transitory narrative, and they're trying to gain it back again?

- The Fed's credibility as an inflation fighter is in their fiber, right? Like, I mean that's just, to them that's so important. It's not only about, well, I mean, you know, and Jay kind of joked about this and, or not joked, but I mean the inflation was transitory. It was two year transitory, not one year. That second year made a big difference in people's lives, right? So you don't wanna make light of it, but I mean the Fed was right, like that inflation was going to come back down. And a lot of it was not about the Fed because growth stayed high. Like they really didn't destroy demand or not as much. Like we had a lot. So, and yet I think to me, the parallel I have drawn, and it does get wrapped up in this transitory, is the '70s, right? The people who had been very critical of the Fed, like Larry Summers, who said they had lost all credibility. They, you know, 'cause they didn't raise rates and like yada yada yada. All those conversations, and looking at the Phillips Curve, they all went back to the 1970s. And I did highlight again, like Arthur Burns, like that was a very dark spot on so many dimensions. So I think if they fear anything, it's the '70s, not in this cycle. But it's all in there together. And yes, they're very weird about, I mean very few people have questioned the Fed's credibility as being serious about inflation, but some really loud, prominent people have.

- So I get just an anecdote, in 1986 when I was in my PhD program, I spent a summer as an intern at the Fed, and people were saying all kinds of nasty things about Arthur Burns. Like you would've thought he was Lucifer himself. And you know, I was nobody, I was an intern, but I still had people pummeling me with insults about Arthur Burns. And isn't it great to have, Volcker was the chair when I was there. And I mean Volker was great, but it was embedded in the fabric of the place at the time. So Arthur Burns will be sort of a cudgel, I think, forever now.

- Yeah.

- [Richard] I'm sorry Claudia.

- Oh no, I was just gonna say, and Volcker is lionized. Like he could do no wrong. And Jay Powell said early on this crisis, Paul Volcker is his hero. And I just, I took a deep breath. I was like, so yeah, so it is interesting. But yeah, I think like getting inside the Fed's head, like these are, it's real, like, and it affects decision making even if you don't think it does.

- So a question I wanted, so I wanna ask you a broad question. So you showed how well we are doing as an economy, and if you go back even further to the GFC, we've done even better relative to our peers over that longer period of time. And the thing that, the only reason I know this, is there was a piece of The Economist three or four months ago that said Germany's per capita GDP had gone from 90% of the US to about two thirds of the US over that period of time. And I always, you know, I sort of had internalized the German number in my head, that 90%, 'cause I thought, yeah, 90% of us in six weeks of vacation every year doesn't sound like a bad trade off to me. But two thirds is a whole other thing. The other thing is that if you dive into the data, you know, what we've seen since the pandemic is income's at the bottom of the income distribution have been rising pretty rapidly. And our measure of inequality, the Gini coefficient has actually been falling. So in light of all that, you know, we're doing better than the rest of the world. People at the bottom are doing better than they did five years ago. Why are people so upset? Why are people so angry? Why don't people feel better?

- I have spent an immense amount of time on this question, and I'm not alone. I mean, this is a big question right now. My, well again, like this is pretty complicated. So there's no one thing going on. A piece of it, and I mean, this just has to be the case given when the timing showed up, is like COVID was really damaging, right? Like there is a, what you see in the data, and this, and when I say the data, these are surveys of people asking about their jobs, their income, their wealth, right? So I mean, the aggregate data are people rolled up into a big number, and they were great. I mean, I was showing you a lot of those numbers, people are doing, they're better. They're clearly better off than before COVID, you can kind of on different measures, is Biden or Trump, you know, but like, but if you ask people, are you better off? How do you feel about the future? In general, if you ask 'em about their finances, it's getting to a better place. Like whether the Democrats or Republicans, they'll say basically, eh, a lot of 'em will say they're better off. If you ask 'em about the economy, it's just like bad, especially if you're a Republican. Now, there's always this political bias. I mean, you see this in the sentiment, you know, if your person's in the White House, you're more upbeat about the economy when they're not. So there's the politics piece. I think on top of that, you just have this like, COVID really, really broke us, and with the passage of time, and we are seeing people slowly get less extra gloomy. So there's that piece. And the last piece is we, I mean we're living, not all technologies are good, aren't always good. I mean the amplification of bad news is a real thing, right? And there is research showing that news organizations promote bad news. If it bleeds, it leads, I mean, this is not new. What has changed over the past several years is you get it into various kinds of social media where people get their news, and there are studies that, you know, mainstream news organizations are more likely to put up negative tweets, and the negative tweets are much more likely to get amplified. So you just, and now, I mean, as an economist out there trying to say they're, or even just trying to represent reality, whether it's good or bad, the amount of disinformation that is just a wash, it like is just, it's overwhelming for someone like me. And I at some point, you can't really blame people for think, I mean, they do choose their news sources. So, but I mean it really is frightening. So it's like the, yeah, it's bad. And this will not get notably better this year, right? Like, because there's like this politics.

- So, well Claudia Sahm, thank you so much for yet another informative and entertaining hour with us on Lusk Perspectives, and I hope you'll come back sometime.

- Yeah, thank you. Appreciate it.