Joe Hazell, Assistant Professor of Economics at the London School of Economics, joins the podcast to discuss inflation. Joe breaks down the reasons for the lack of inflation in the pre-pandemic period and the primary causes of inflation over the past four years. The team discusses why the average American is much more sensitive to inflation than unemployment and whether the Fed should rethink how it balances the two when considering monetary policy. Finally, the discussion turns to the incoming Trump administration’s policies and their potential effect on inflation over the next few years.
Joe Hazell, Assistant Professor of Economics at the London School of Economics, joins the podcast to discuss inflation. Joe breaks down the reasons for the lack of inflation in the pre-pandemic period and the primary causes of inflation over the past four years. The team discusses why the average American is much more sensitive to inflation than unemployment and whether the Fed should rethink how it balances the two when considering monetary policy. Finally, the discussion turns to the incoming Trump administration’s policies and their potential effect on inflation over the next few years.
Guest: Jonathon Hazell - Assistant Professor of Economics at the London School of Economics
Papers mentioned in this episode: Why Do Workers Dislike Inflation? Wage Erosion and Conflict Costs and The Dominant Role of Expectations and Broad-Based Supply Shocks in Driving Inflation
Hosts: Mark Zandi – Chief Economist, Moody’s Analytics, Cris deRitis – Deputy Chief Economist, Moody’s Analytics, and Marisa DiNatale – Senior Director - Head of Global Forecasting, Moody’s Analytics
Follow Mark Zandi on 'X' @MarkZandi, Cris deRitis on LinkedIn, and Marisa DiNatale on LinkedIn
Mark Zandi: Welcome to Inside Economics. I'm Mark Zandi, the Chief Economist of Moody's Analytics, and I'm joined by my two trustee co-hosts, Marisa DiNatale, and Cris deRitis. Hi guys.
Cris deRitis: Hey Mark.
Marisa DiNatale: Good morning, Mark.
Mark Zandi: How's it going?
Marisa DiNatale: Good. Great.
Mark Zandi: Good, good. So I joined Bluesky. You know Bluesky, the new social media platform?. Have you been [inaudible 00:00:36].
Cris deRitis: Oh, I see.
Marisa DiNatale: I've heard about it, but I don't know much about it.
Mark Zandi: Yeah. I just posted my first post this morning. I have 115 followers. I don't know how that happened, but I'll take it.
Cris deRitis: Are you off of X?
Marisa DiNatale: Are they all bots?
Mark Zandi: Yeah, right. I think on Bluesky, they're legitimate, I think.
Marisa DiNatale: Okay.
Mark Zandi: For now. For now. Yeah. And my off X? Not yet. Should I be off X? What do you think?
Cris deRitis: I'm not on it so.
Mark Zandi: Oh, you're not on it. Right.
Cris deRitis: If you want to come over to LinkedIn.
Mark Zandi: Should I? Should I do that? Yeah. I don't know. I don't know. But anyway, we'll see how this goes. Good to have an alternative out there. And I saw Paul Krugman is on there and Jason Furman. I haven't looked really a lot, but just very curious what you thought. So what else? Anything else going on before we dive into things? Any other news? I see it's snowing here in the suburban Philly.
Cris deRitis: That's the big news. Yep.
Mark Zandi: That's the big news. That's big news.
Cris deRitis: Local news.
Mark Zandi: All right. Okay. No big news. Well, we have a guest, Joe... You know, Joe, is it Hazell?
Jonathon Hazell: Hazell. That's right.
Mark Zandi: I'm so sorry.
Jonathon Hazell: It's the double L.
Mark Zandi: Also, I just call you Joe. I don't know, I never called you by your last name, Joe Hazell. So it's good to have you on.
Jonathon Hazell: It's great to be here. Thanks for having me. Mark, Cris, Marissa. Really excited to get into it and get into some economics.
Mark Zandi: So are you a Twitter guy?
Jonathon Hazell: I was thinking about this. So I'm actually, I'm using both right now. So I think it's good to keep the platforms competitive, exert some market pressure. I use them both. I'm more of a consumer than producer. And at this stage you, notice that different subgroups have segmented into different platforms. So the people who are active on LinkedIn, X or Twitter and Bluesky, just different people. So academics are all on Bluesky. I think media is still mostly on X/Twitter, businesses on LinkedIn. And I want all of it. So I try. And I'm in my spare time I'm a big runner as a hobby and they're all on Instagram, so why not use them all? And then the hope is that you keep these giant corporations a little bit competitive because they've got the pressure that you're able to switch freely.
Mark Zandi: Right. I should have known that. But that makes perfect sense. Academic, business and media. It didn't dawn on me, but that makes a lot of sense. But doesn't it take a lot of energy to be on all those platforms?
Jonathon Hazell: I am a dreadful procrastinator, so I have the time for [inaudible 00:03:20]. So my embarrassing secret, the way that I get stuff done is I like to spend, every half an hour, I like to take two or three minutes to procrastinate, to recharge my energy. It's perfect to spend just a couple of minutes meandering around social media during that short interval. So that's my dirty secret.
Mark Zandi: I was going to say, I mean you seems so productive. The procrastination doesn't seem like that would be in your MO.
Jonathon Hazell: I like to think it's part of the process, but who knows.
Mark Zandi: Part of the process.
Jonathon Hazell: Tap them leaving all on this money on the table. We'll see.
Mark Zandi: Well I think everyone can hear that accent. So that's a British accent.
Jonathon Hazell: British accent. Exactly.
Mark Zandi: And you're teaching at LSE?
Jonathon Hazell: Correct.
Mark Zandi: And I told my wife, I'm going to be talking with you today, and she said, "Oh, tell him that I went to LSE."
Jonathon Hazell: Oh, fantastic.
Mark Zandi: So she went to LSE for a year.
Jonathon Hazell: It's a wonderful place. I'm really lucky. You can feel the history in the hallways. We've had these amazing economists. Hayek went there. John Hicks. So Arthur Lewis, the first development economist, William Beveridge of the Beveridge Curve, your wife, I mean all of these.
Mark Zandi: She'll love this podcast.
Cris deRitis: [inaudible 00:04:32].
Jonathon Hazell: Yes, it's an amazing place. I feel very-
Mark Zandi: It was a pretty tough year. She said you guys work pretty hard over there.
Jonathon Hazell: No, it's tough. And I should say one more, which is Arthur, is it Arthur? Arthur Phillips, the inventor of the-
Mark Zandi: Oh, is that right?
Jonathon Hazell: Also went to LSE. So we have this amazing pedigree. So Arthur Phillips actually invented the first computer for macroeconomics. So I guess in the early 1950s he invented this computer which was actually based on water. So the idea was you would see how the economy would flow around. And so we would have this system where the water would flow around the economy using various pipes and so on, and plugs a bit like some very complicated water wheels slash bathtub and he would use it to try and forecast the economy. So we have A, somewhere in LSE, though I haven't seen it yet, is the original macroeconomic computer model. So it's an amazing place.
Mark Zandi: Oh that sounds fascinating.
Jonathon Hazell: It's very cool.
Mark Zandi: And he actually tried to use this to...?
Jonathon Hazell: He did.
Mark Zandi: Wow.
Jonathon Hazell: Methods have come on since then.
Mark Zandi: Yeah. Yeah. That's pretty amazing. So how long have you been at the LSE?
Jonathon Hazell: I've been there for three years now.
Mark Zandi: Three years.
Jonathon Hazell: So this is just the start of my fourth year. I'm a sabbatical right now in California, but no, I've been there for three years and it's an amazing place to be. It's an amazing environment.
Mark Zandi: Why does that happen? You get sabbatical after three years, what the heck is that all about?
Jonathon Hazell: Well, academic sabbatical just means you have equally terrible work-life balance in another place that isn't your home institution. So it is not the holiday that you might [inaudible 00:06:01].
Mark Zandi: I see. Is there still such a thing as sabbatical where you actually get time off to go think?
Jonathon Hazell: I think I always say to people that the challenge of academia is that it's like you're on a holiday all the time and never. Because in some ways the mechanism, in the next year, if I took all of my time off, that would actually be, other than showing up to teach a few classes, that would actually be within the realms of the contract that I have and so on. But instead, I spend all my time researching. So for sabbaticals, you can do whatever you want with them, but most academics use it to research.
Mark Zandi: To work. To work. Yeah.
Jonathon Hazell: Yeah, exactly.
Mark Zandi: Yeah. The way we got to know each other was you knocked on my door and you said, "Hey, I'm doing this research on inflation, the causes of inflation. And I'm very interested in the work that you did around the senate races back in Georgia," because that was a key point, crossing point with regard to what fiscal policy in the future would be like and ultimately what that might mean for inflation. And you produced a study. Can I ask though before I hand it over to you, and maybe you can describe this in more detail, is inflation and inflation dynamics where you're most focused in your research or is it broader than that?
Jonathon Hazell: So inflation is the core. It's something I've always been fascinated with ever since I started thinking about economics. It's just one of those fundamental deep questions, so even before. And of course the best thing about it is it's always interesting. So before this post pandemic inflation, there was a long period when inflation didn't move very much. And that was also a great time to write papers about inflation because you have the puzzle of what people call the flat Phillips curve before 2020 and now inflation's high. So that's interesting to write about too. So I think it's a perennially interesting topic because there's always something happening or failing to happen and that's my main focus for now at least.
Mark Zandi: Okay, so that's interesting. Because I was going to say, that must've been pretty boring place to focus before the inflation actually took off, but you make a great point. Inflation was very low and suboptimal for a long time, so that's also an interesting.
Jonathon Hazell: Absolutely.
Mark Zandi: Yeah.
Jonathon Hazell: So before 2020, people used to talk about the last 40 years of US macro history in this interesting way that raised puzzles. In particular, during the 1980s. There was a very strong co-movement between unemployment and inflation. And then over time, ever since it fell and fell and fell. So during the 1990s, during the 2010s, unemployment was very little bit inflation wasn't very high. And so people called this the missing disinflation or the missing re-inflation, which was that in the decades before the pandemic, inflation and unemployment didn't move very much relative to the 1980s. And one thing that I was trying to do before the pandemic happened was simultaneously think about why it is that inflation was so sensitive to unemployment back during the Volcker times and yet less sensitive since. And of course every new data point creates a new puzzle for us, which is after the pandemic, maybe we're back in this world of a stronger move to unemployment and inflation, although it's not so clear.
Mark Zandi: So before we move on to the work that you did, the study around the pandemic and inflation. And obviously it's very, very critical conversation around what caused the high inflation of 2021, '22 going into '23, because that goes to what the appropriate conduct of policy is and what that might mean for future policy makers and how they think about these things. So it's really an important debate. But before we get there, what's your thinking around why inflation was so suboptimal between the financial crisis and the pandemic? It was consistently below the Federal Reserve's target. What was going on there?
Jonathon Hazell: Absolutely. So the way that I've thought about it, I have with amazing co-authors, Emi Nakamura and Jón Steinsson at Berkeley, and Juan Herreño at UC San Diego, we wrote a paper arguing that one can explain both the missing disinflation and the missing re-inflation of the 1990s onwards, and the high inflation and volatile inflation of earlier periods with two ingredients, which I will call maybe the flat Phillips curve and the gradual anchoring of inflation expectations over time.
So let me give you just the quick one-minute summary of this. Economists organizing framework for thinking about inflation is what we call the Phillips curve, which relates inflation to date, inflation expectations and current unemployment. It's very intuitive. The idea is look, if unemployment is very low, inflation all else equal, should rise. And if inflation expectations are high, people are going to realize this and raise inflation today. And these are core ideas, very intuitive, very at the heart of economics. Our simple explanation for why you could have very volatile unemployment in the 1970s and '80s, but relatively not volatile unemployment since, is what originally Ben Bernanke put forward, which was called the unanchored expectations hypothesis. This was the idea that during the '70s and '80s, inflation expectations were very volatile. Why? Because monetary policy was very volatile. It was very unclear what the Fed was going to do, what their inflation target is, what they were planning to do in the near future.
You hear all these stories about Nixon pressuring the Fed in the earlier part of that period. And then Volcker, resolutely saying, "We're going to bring down inflation no matter what." If you look in the data, inflation expectations are all over the place in this period. So that can really explain why inflation was so volatile in that early period. After about 1985, the United States, you see inflation expectations are really flat, really anchored. At that point, inflation itself stops moving. So we think that really what's going on with this period of volatile inflation before 1985, but relatively quiescent inflation after 1985 is the gradual increasing credibility of the Fed that kept expectations more anchored over time.
Leaving that on one side, we were also saying that conditional holding fixed inflation expectations, unemployment itself wasn't having very big effects in inflation, which is to say even when unemployment became very low, it was unlikely that inflation would rise very much so that was the paper. And we had some new arguments based on regional data that we think fleshed out that idea a little bit better than people have been doing previously.
Mark Zandi: Like most things, there's more than one explanation. In my narrative around that period of time in inflation was also the fact that China was really coming on in a big way. And that created a significant amount of actually deflation on the good side of the economy.
Jonathon Hazell: Yeah. Yeah. Yeah. Absolutely. So I don't think this is the only story. The fact that we brought to the table that supported our story a little bit was to go to regional data. We constructed some regional data, so we actually made state-level price inflation index. State-level price inflation indices for the United States quarter by quarter from 1978 onwards. These didn't exist before, which is a little bit surprising. And with that regional data, we studied the co-movement within regions between inflation and unemployment from 1978 onwards.
Now what we found is that in regional data, the co-movement between unemployment inflation was actually very, very stable over time. Why was that interesting? Because regional data in some sense, when you're comparing two regions and how their inflation and unemployment is moving in one region relative to another, what you're doing is you're holding fixed what's going on at the aggregate. And one of the things you're holding fixed at the aggregate is Federal Reserve policy, Federal Reserve inflation, the inflation target of the Federal Reserve and so on.
And the thing that was pretty interesting was that a lot of stories for why over time the relationship between unemployment and inflation might be declining, would show up to some extent in the regional data. If you thought that there was more trade over [inaudible 00:13:46] time, even within regions, unemployment should respond less to inflation. And that's not really what we saw.
For sure, I would say it's part of the story, but what we really liked was that by looking at regional data, we hold fixed issues like the Federal Reserve inflation target. That could be really important for thinking about inflation.
Mark Zandi: Yeah, very cool. We actually construct State House CPI measures. Do you update yours still? Do you still update?
Jonathon Hazell: It's a great question. So in the next few weeks we're planning to do a new release.
Mark Zandi: Oh really? Okay.
Jonathon Hazell: Yes. Yes. I'll let you all.
Mark Zandi: So [inaudible 00:14:16] over that. We do that as well. Please.
Jonathon Hazell: Oh, excellent. Maybe I can ask afterwards, harass for a link to your data.
Mark Zandi: Yeah, absolutely. Yeah. Yeah. One of our colleagues, Adam Kamins, has spend a lot of time on this and I know he updates it every month. Yeah, absolutely.
Okay, so let's move forward to the study you did on inflation around the pandemic. And you're really focused on this. And I'm going to frame it, and you just tell me if I got the frame right. But basically the argument or debate has been raging around what caused the acceleration in high inflation that began in the second half of 2021 throughout 2022 coming into 2023, demand and supply. And I think everyone would agree that's both demand and supply, but where you land on that in terms of whether it's more demand or more supply, has big implications for policy and what the appropriate conduct of policy is.
Jonathon Hazell: Absolutely.
Mark Zandi: So is that a reasonably good frame for the-
Jonathon Hazell: That's exactly the frame.
Mark Zandi: Okay.
Jonathon Hazell: So exactly like you're saying, Mark, that I think is the key question of the last four years, which is... Or the way I would put it is that around the world, deficits were high, inflation was high, and there's a question about whether or not the two are related. And it's related to this classic question of whether or not deficits cause inflation. But of course, like you're saying, it's very hard to know because we have a single data point, a single times series, we have lots of shocks going on at the same time. We have this deficit shock from the Biden administration in 2021, but then we also have supply shocks like oil shocks, supply bottlenecks, lingering effect of the pandemic itself. So there's lots of stuff going on that could have caused the inflation. What we were trying to do was trying to tease out the effect of deficits separate from these other inflationary shocks.
And of course that's hard. It's the classic emitted variables problem, but it's particularly severe here because you've just got one period of time and you have loads of different shocks. So disentangling one of them is different.
What we tried to do is we tried to introduce what we call a high frequency narrative approach. The idea here was using the historical narrative to find a specific event that released a great degree of news about inflation, and then look at the high frequency response of asset prices of inflation expectations from swaps to see what the effects may have been on inflation. And the appeal of this is that if news about deficits during this window is released separate from any of the other shocks that drive inflation, then maybe one can get a handle on the contribution of deficits. I'll say more about that as I say how we did it.
So the event that we focused on was the 2021 Georgia Senate election runoffs. So you probably remember exactly what happened, but for your listeners. In 2021, at the start of 2021, President Biden had just won his presidency and had 48 senators, but there were two Senate seats that were too close to call in Georgia. If Democrats were to win both of these Senate seats, they'd be able to pass their fiscal stimulus. But if they didn't win both Senate seats or they lost even one of them, Republican would've a Senate majority and Democrats wouldn't be able to pass fiscal stimulus. So these Georgia Senate elections, they were pivotal for the chance that Biden would be able to pass his stimulus. That's the key context. And what we're going to do is we're going to study what happens to inflation expectations around that one event.
Now what you need is you need a measure basically of how much news was released to markets about the size of deficits. When we go from a 50% chance of Democrats winning just before this Georgia runoff in January, 2021, to 100% chance of Democrats winning after they've won. We are releasing a bunch of news about the likelihood of deficits when we go from a partial chance of Democrat victory to a full chance of Democrat victory.
So how do we measure how much news? Well that's when I came to you, Mark, because I said, look, places like Moody's, on the eve of the election, just after the election, are going to say things like, "Well, we think that if Republicans win this election then there's going to be a certain amount of deficit spending, and if Democrats win, there's going to be a certain other amount of deficit spending." The consensus reading your reports, as you remember at the time was to say, look, if Democrats win, there's going to be a bunch more spending. Something like a trillion dollars. And if Republicans win, there probably isn't going to be. And that's based on my pigeon understanding of U.S. politics that when one side has the presidency and the other side has the Senate, nothing gets done. And so my sense is that where you were coming from as well.
And so the second part of this narrative piece is to say, well, reading carefully the reports, like the reports that you generously shared with me. When Democrats win in Georgia, that releases to news to markets that probably we're going from a 50% chance of a trillion dollar stimulus, that is to say a 50% chance that Democrats win and enact a trillion dollar stimulus, to run 100% chance of a trillion dollar stimulus. Because once Democrats have won, they're definitely going to pass it. So that was the narrative part, trying to carefully measure around the standard election exactly how much news about deficits was released.
Mark Zandi: And you got a number of different investment banks, other forecasters to participate. I think it was about 20 or so.
Jonathon Hazell: That's correct. Exactly.
Mark Zandi: That must not have been easy to do. That must have been-
Jonathon Hazell: No, it wasn't. So the first one we started with was actually you guys. And you were most more comfortable-
Mark Zandi: Oh, is that right? Okay.
Jonathon Hazell: But what we wanted to do, so we started by reaching out to you because we wanted to have some sense of is this going to work? We really got into details and read everything. And then once we had a sense of this is the thing that people commit to paper, then we wanted to see as many as we could to have the maximum sense of this is what the market's thinking. But there's a fair consensus at that time that Democrats were likely to spend about a trillion dollars if they want, and that Republicans were likely to enforce no more spending if Democrats lost in Georgia.
Mark Zandi: Of course they went on and spent $2 trillion, right?
Jonathon Hazell: Yeah, exactly. So this is one of the interesting things.
So what you guys said at the time, and this was the consensus, was that well, Democrats are unlikely to spend more than a trillion because the margin of Democrat senate is relatively conservative. And then over February and March, a bunch of negotiations take place so that in March, 2021 when the deficit packages eventually passed, it turns out to be quite a lot bigger, quite a lot more permissive. Because the marginal Democrat, Joe Manchin of West Virginia turned out to be more favorably inclined to stimulus than anyone thought in January.
But in January people thought it was going to be a trillion dollars. And so that's number [inaudible 00:20:35]. So that's the narrative piece on how much markets expected would happen to deficits as a result of the Georgia election. The high frequency piece is, so okay, so what happened to inflation? How much did markets expect inflation was going to rise as a result of this news about deficit spending? And the answer is it seems to be quite a bit. So inflation expectations jump up around the news about the stimulus.
So over the next two years, markets expect 40 basis points more of inflation, and it's expected to be quite persistent.
Mark Zandi: And this is what you glean from swaps? Inflation swaps,
Jonathon Hazell: Exactly.
Mark Zandi: Right.
Jonathon Hazell: It's extremely simple. You pop the swap and you see that the swap price just jumps around the news of Democrat victory. It's that simple. Then the final part is to say, well look, what we've got here from this window is we've got a measure of for a given extra deficit dollar, by how much do inflation expectations rise? And what you can do is you can take that increase in inflation expectations per dollar of deficit spending, and you can scale up the total deficits over this period by that inflation per deficit dollar amount to figure out the total effect of deficits on inflation. You just extrapolate from this narrow window how much deficits were expected to increase inflation, to figure out how much total deficits caused inflation.
And the number that we get, which I guess agree with my prize, but it's useful to have better evidence on this, the deficit stimulus has probably caused something like between a third and a half of the inflation over 2021 and 2022.
My takeaway from that is that deficits were probably barely important for inflation, but other shocks were probably equally if not more important, and there's no shortage of other shocks over this period. Supply shocks, bottlenecks, that kind of thing. And so I suspect it was a mix. I suspect it was a bit of a perfect storm of perhaps a little bit too much demand stimulus, although not, I think crazily ante excessive amounts, combined with some difficult supply shocks at the same time like the Russia-Ukraine war and so on, that also pushed up inflation.
Mark Zandi: You came up with a cool rule of thumb, you called it an inflation multiplier where I think it was point, if memory serves, 0.18.
Jonathon Hazell: Yes.
Mark Zandi: So for every percentage point increase in the deficit to GDP, that would add, ultimately over I think a couple of year period, 0.18% to inflation.
Jonathon Hazell: Exactly. And take that number and multiply it by the total amount of deficits, the GDP, and then you get some kind of back of the envelope of how much deficits led to inflation.
Mark Zandi: Well, and you came up with two to two and a half percentage points and inflation was closer to six, six, 7%. So therefore that's how you got to the third kind of thing.
Jonathon Hazell: Yes. Exactly. That's exactly right.
Mark Zandi: Right, right. Well, it's very intuitive. In some of the email conversations we had that followed, the one thing that I questioned or was just curious about was whether that inflation multiplier is a constant, whether it is a function of the state in which you're in.
Jonathon Hazell: Totally.
Mark Zandi: Because if you look at traditional multipliers, and for the listener out there, you're just looking at what is the impact on GDP or the impact on jobs from an increase in fiscal policy, government spending or tax policy. Those multipliers, they're thought to be, that they change, they're function of what's going on. If you're in a weak economy, the multiplier is larger. If you're in a full employment economy, the multipliers are smaller. Is that same? Does that work here as well?
Jonathon Hazell: Absolutely.
Mark Zandi: Okay.
Jonathon Hazell: So my mental model is that monetary policy is very important for the size of either the classic multiplier, linking government spending to output. Or what I'm calling the inflation multiplier, which links government spending to inflation. And as a thought experiment, imagine the following two things.
First, as a government spending shock of some kind, and the Fed hikes interest rates enormously and immediately, then the effect on inflation could be zero or even negative. And if the Fed does nothing or cuts interest rates immediately, then the effect on inflation could be very, very big. And so of course a range of things are possible, and this multiplier that we were talking about is a multiplier conditional on the stance of monetary policy.
One of the other things that we're able to do is just look at the stance of monetary policy. And how do we do that? Around this shock, you can see market's expectations of all sorts of interest rates, the short-term bond rate, the future guesses of what the federal funds rate and so on will be. And the striking thing here is that markets believe that monetary policy will be relatively loose in response to the fiscal shock, which is to say that in the short run, markets believe that nominal interest rates aren't going to change at all after this fiscal shock from Georgia. Meaning that in real terms, short run rates are falling by quite a bit in response to the fiscal shock. This is just that loose monetary policies is part of why deficits have this reasonably large effect on inflation.
Now, I always caveat here that I don't want to engage in I guess what you Americans would call Monday morning quarter backing, because I mean I think the Fed-
Mark Zandi: No, go ahead Joe, please feel free.
Jonathon Hazell: I think ex post, the Fed, there was probably a little bit too much demand stimulus this by the Biden administration, a little bit too much monetary accommodation by the Fed. But on the other hand, at the time it was a little bit difficult to know that. And the flip side, the byproduct or the benefit of this higher inflation was an extraordinarily good GDP growth performance. And I always try to emphasize this. So this is another thing that we can see in the data, which is that if you look at proxies for GDP growth from investment bank forecasts from asset prices. Markets price in response to this fiscal shock, really tremendously good GDP growth performance. And that's one of the real benefits, that accompany this higher inflation. And it accords with our traditional view that when you have a big demand stimulus output goes up and inflation goes up.
So I think it's important to stress that it's not clear to me this was bad policy because one had a little bit higher inflation, but at the benefit of a very strong real side, a very strong output performance.
And I looked to Europe, looked to my native UK, which over the same period as America from the end of 2020 till 2022, saw a stagnational decline. And I think perhaps American policymakers did a very good job because the American recovery, the American GDP performance of the last four years is really extraordinary and remarkably good compared to anything in Europe. And in some ways, America has had high inflation, but everywhere has had high inflation and yet American prosperity and American recovery is the envy of the world.
I do want to stress a balanced view that I think perhaps ex post there were some mistakes made, but it's not clear. And these mistakes had at the least benefits accompanying them that were quite evident to.
Mark Zandi: One other consideration is at that time, this is my recollection of the period when we're talking about early 2021 now with the American rescue plan, that's the $2 trillion package that we're focused on here. That that was deemed to be, let me call it good inflation. That as we were talking earlier, inflation had been suboptimal. I mean below the feds 2% target, really since the feds started targeting inflation in 2012, officially started the 2% target in 2012. Up and through that period, inflation had been consistently below target. So in 2020, the Fed changed its policy framework and said, "Hey look, if you've experienced a period of suboptimal inflation. Now I want a period of inflation above target to make the price level more consistent with what it would've been otherwise."
And here we were, inflation in 2021 picked up as we've been discussing, but that was not a problem. That was good inflation. Here we were, the Fed got exactly what it wanted. The inflation became a problem later in 2022 when we got another supply shock, this is on the supply side, the Russian invasion of Ukraine. So it's almost like you got exactly what you wanted. You got inflation back to the feds target, and you got an economy that's performing much better. And as you pointed out, better than anywhere else on the planet, the U.S. economy is now leading the way across the globe. So from my perspective, it's almost like that's the exact policy you wanted.
Jonathon Hazell: So I'm very sympathetic to this.
Mark Zandi: You are? Okay.
Jonathon Hazell: [inaudible 00:29:21]. Some caveats.
Mark Zandi: Darn. I was hoping you wouldn't be because we could fight over this. But go ahead.
Jonathon Hazell: Let me give you my sympathy and then my caveats.
Mark Zandi: Yeah, okay, there you go. He's very smooth. I agree with you, maybe not so much. Okay. Go ahead.
Jonathon Hazell: No, I think this is basically right. I don't fully agree, but I mostly agree.
Mark Zandi: Okay.
Jonathon Hazell: I certainly think ex ante, this was a very sensible decision, even if ex post, that been surprised. So let me say where I think this makes a lot of sense.
Okay, imagine the following scenario. Imagine that the US had done this stimulus and then there had been none of these adverse supply shocks. Taking the numbers from my paper seriously, which I think in a ballpark sense, are pretty reasonable inflation might've overshot to maybe 5% for one year, two years, and then gone back down to 2%. And I think that basically would've been fine alongside an excellent GDP recovery. The Fed of heroes, the Biden administration of heroes, everyone sets off into the sunset. The problems of the pre-2020 economy, the overhang of the great Recession, excessively low interest rates are in the rear-view mirror. You have a great output performance, moderately high inflation, and everyone's happy. I think that's a very plausible scenario. And instead, the Biden administration were unlucky with some adverse inflationary supply shocks that affected many countries. I think that that's probably true. And I think that's a big part of it. So that's definitely my point of agreement.
My caveat is that relative to what I believe in 2020, I, and I think many people, including maybe yourselves, have revised up how much people dislike inflation relative to unemployment. And so I think from the standpoint of 2020, a trade off that says inflation going to 5% for one to two years with an excellent GDP growth performance and unemployment falling very rapidly feels like a very favorable trade-off. From the standpoint of 2024, that seems like, well, if we think that actually people dislike inflation more than unemployment relative to what we previously believed, perhaps that menu of policies is a bit less attractive than we thought.
And here I'm thinking about this idea, which sometimes people call this "vibe session", which is that consumers right now seem more pessimistic about the economy than they were at any time during the long slow recovery from the growth recession. So unemployment was very high at the time. Everyone rightly thought this was a very bad situation. People were very upset, but they seem more upset now with what I view as a relatively modest inflation. But it's not my position to say what people should think is modest or not. It's clear that people just really hate inflation, perhaps more than they hate on unemployment. And perhaps that's because inflation affects everyone and unemployment only affects the select few who are unfortunate enough to be unemployed. But that's something that policy has to take into account. So that's my caveat. I agree with you that there was good inflation plus bad luck. On the other hand, even good inflation seems a bit more disliked than I would've guessed.
Mark Zandi: Okay, you make a great point. That's a great point. What you're saying is, look, the Fed's waiting inflation, the Fed says, I want inflation above target so I can make it all iron out. But maybe that's not the right strategy in the context of the fact that people really hate inflation much more than they hate unemployment.
Jonathon Hazell: Exactly. And it's not what I expected. And I think people two generations older than me who lived through the 1970s was sagely saying this to me. And I was saying, "You don't anything, times have changed." But maybe times didn't change. And I was very surprised by this. I wrote a paper trying to reevaluate why people dislike inflation so much. And that's probably the biggest lesson that I learned from this period, because I think our basic mental model describing the world of, well, what's going to happen to inflation after a bunch of supply and demand shocks worked fairly well, I think, which is that the U.S. is a big demand shock and a big supply shock. So output does pretty well, but inflation goes up by a lot. I think that model basically worked, but even as our descriptive model of the world worked pretty well. I think our model of how people feel, what economists sometimes call our model of welfare or our normative model of the world, I think that worked pretty badly in that people seem really, really upset about this in a way that I wouldn't have guessed.
Mark Zandi: That's really interesting. And Cris, you've made this point to me as well in the context of the Fed's reaction function, because you got unemployment, you got inflation, and they seemingly equally weight the two. And the reaction function is I look at inflation, I look at unemployment, I look at financial conditions, I look at stuff, and then I say what's the appropriate federal funds rate target? And they tend to equally weight the unemployment objective and the inflation objective. And Cris, you were arguing, well, maybe they shouldn't be doing that, given exactly what you said, Joe, that people really hate inflation. Did I have that right, Cris?
Cris deRitis: Yeah, that's the conjecture.
Mark Zandi: Yeah, it's really interesting.
Jonathon Hazell: I think the Fed is also learning this over time. I mean, I think the Fed basically... I'm pretty confident that I'm summarizing the conventional wisdom of 2020 that the Fed believed, and I think the Fed has probably [inaudible 00:34:36]. One thing that's remarkable about the Fed that's very impressive relative to other central banks is I think over this period, they were a little bit slow off the mark, but I think they were relatively quick updating their framework and their view of the world as new information came in. And I think that's really commendable. I think the ECB, the Bank of England obviously took a lot longer to react to changing circumstances. And I think probably within the Fed, what I'm saying is uncontroversial, which is that in 2020, we thought one thing about the social welfare function of the relative cost of inflation and unemployment, and we realize that's wrong and it's a lesson we'll learn going forward. That's my guess. I mean, I don't speak to the Fed, but maybe you do. I mean maybe that's [inaudible 00:35:14].
Mark Zandi: Well, no, no, no, I think that's exactly right. I mean, although everything in macroeconomics, we got just one more data point, so it's hard to draw lot of strong conclusion.
Jonathon Hazell: Totally. Totally.
Mark Zandi: Because there's a lot going on here and this gets to your most recent paper you just to us, which is actually very interesting around this topic. Trying to explain why people hate inflation. Did you want to talk about that?
Jonathon Hazell: Oh, absolutely.
Mark Zandi: Yeah. Yeah.
Jonathon Hazell: So I always like to, when I try and explain this paper to people, I always like to start with an anecdote of when I first had this discussion with my mother many years ago. And so we were talking about why people... My mother is not an economist, but she's a woman of great common sense. And so we were-
Mark Zandi: Like my wife, I'm just saying.
Jonathon Hazell: Yeah, exactly. Exactly. Well, no, but your wife famously is an economist. That's the difference. My mother is a doctor. So I said to her, "Why do you think people dislike inflation?" And she said-
Mark Zandi: Hold it. Wait a second. Wait a second. Joe, are you making this up? You actually had a conversation with Mom about why people hate inflation?
Jonathon Hazell: Yeah, absolutely.
Mark Zandi: Okay. All right.
Jonathon Hazell: And precisely to this point, I think inflation is something that people out there in the real world, not just nerdy economists like us do have very strong opinions about.
Mark Zandi: Yeah. Right.
Jonathon Hazell: So she may have initiated the conversation this, but I don't remember, but she said, "I don't like inflation because wages don't keep up with prices." I've still got the same amount of money, but everything's becoming more expensive. And I think if you speak to anyone out there on the street, economists, anybody, I think this is normally the first thing that comes up. And there are influential surveys, a classic one by Robert Shiller, the Nobel Prize winning economist, and a more recent one by Stefanie Stantcheva, who's a Harvard professor, that finds that this is universally why people dislike inflation. However, traditionally, economists have dismissed this reason for why people dislike inflation for one good reason and one bad reason. So the bad reason is that economists say, as I said to my mother at the time, they say, "No, no, no, that cannot be the cost of inflation because when prices go up, wages should rise too. And if wages and prices both go up, then everything's fine. Your wages have not risen more than prices because wages should rise with prices." And this is a theoretical argument motivated on the idea that the invisible hand of the market will make sure that when prices rise, wages rise too, and that no one's worse off.
And so this seems like it relies on this strange, worked out logic that only an economist could dream up. And this is what Mankiw says in a [inaudible 00:37:44]. He said, "This is not a cost of inflation because wages should rise to when inflation goes up. So wages can't be outstripped by prices." A slightly more reasonable version of this is economists point out that if you look at time series data, often during periods of inflation, prices do keep up with wages. So during periods of high inflation, often the labor share of income doesn't fall often. Real wage growth is fairly strong. Over this recent period, the statistics are pretty contested and a little bit messy. But what is clear is that at least for low wage workers, real wages did perform fairly well over this episode, yet low wage workers still seem very upset about inflation.
That's the scene setting, which is that people have this strong view that one of the challenges is wages don't catch prices, but economists say maybe the data doesn't fully support that.
Mark Zandi: There is a lag, right?
Jonathon Hazell: There's a lag. Absolutely.
Mark Zandi: I mean, prices go, and then wages don't go for a year or two maybe. Because of [inaudible 00:38:40].
Jonathon Hazell: Yeah, and the lag is going to be core to what I'm about to say.
Mark Zandi: Yeah. Yeah. Okay.
Jonathon Hazell: I think the lag's really part of it. Our perspective is just to say, well, perhaps when there's inflation, workers need to take costly actions in order to have wages keep up with the prices, they need to fight with their employees. Perhaps they need to take industrial action, go on strike. Perhaps they need to search for another job. Perhaps they need to have a tough conversation with their employer. All of these are very costly actions that workers need to take to have wages catch up with prices.
Take the example of me, I'm an assistant professor at the London School of Economics, as you know, and over the period of high inflation, LSE gave me a nominal raise of approximately 0%. And so I have to contemplate, will I go on the job market? Will I search for another job just to get my wages back? And that's obviously very costly, and perhaps eventually at some point I will have to do this.
So notice then that real wages no longer summarize the costs of inflation. Real wages could not change at all during a period of high inflation. Yet there could be these enormous costs going on in the background, which is that real wages are staying level precisely because workers are exerting all these costs in the background in order to have wages catch up with the prices. So that's the key observation.
I think it reconcile, it can reconcile my starting tension between the people and the economists Because my sense is that what's going on a lot of the time, and there's some survey evidence and support of this, including survey evidence that we provide in our paper, is that people say, "well, I really don't like this feeling that wages aren't catching up with prices. So what I'm going to have to do is I'm going to have to take all these costly actions to rectify the situation by getting my wages to increase." But that stuff's pretty painful because that means, in my case, that might mean some extremely difficult and challenging costly negotiation process.
One other fact in support of this is that over the recent episode, and more generally, periods of high inflation are also periods when there's lots of industrial action. So periods when workers and firms seem to be conflicting a lot because workers feel they need to fight with their employers to get pay raises. And then the final anecdote I'll offer in support is I shared this paper idea with an Argentine colleague of mine. He immediately said, "This is exactly right. That in Argentina during the period of high inflation, everyone's just fighting all the time."
And I think there's some truth to that. I think inflation.
Mark Zandi: Of course, Argentines, they've been fighting since the beginning of time.
Jonathon Hazell: Well, that's what I said. So I did-
Mark Zandi: Oh, you did? Okay.
Jonathon Hazell: So I said, "Well, when inflation was low, when I was living in Argentina things..." But yes, the main point, I don't want to do any slurs against Argentina with this podcast.
We haven't seen this exact observation anywhere before, but I think it resonates.
Mark Zandi: The one caveat in my mind is during this period, people avoided conflict by quitting and going to get other jobs mean, what was the phrase? Quit session or quit?
Jonathon Hazell: Great Resignation.
Mark Zandi: Great Resignation. Great Resignation. So it was like they could get their pay increase, and they actually did. If you look at the wages of people who switched jobs, they got pretty sizable wage increases.
Jonathon Hazell: Absolutely.
Mark Zandi: They got better jobs. They were more suited to their skills and education and talents and interests.
Jonathon Hazell: Absolutely.
Mark Zandi: So it's almost like they were able to avoid the recession, but still they were Angry.
Jonathon Hazell: So we think of this as potentially one of the costs, which is that-
Mark Zandi: I see.
Jonathon Hazell: So exactly. So for low wage workers, I think the fact is that low wage workers saw strong real wage growth, realized entirely through job switching. So the low wage workers who didn't switch jobs had big real wage falls, and the workers who did switch jobs had big wage increases. And so in some ways, that seems like a very good thing for exactly the reasons you're saying, Mark. It seems like you get some reallocation that seems very good, people going towards better jobs that are better suited to them. Real wages are very high now for low wage workers of the U.S. That seems great. What we want to do is say, well, the flip side of that, that one should acknowledge is that the process of searching for a new job is, in any given year or any given five year period, is probably one of the most costly things that a person can do outside, professionally is one of the most costly things that a person can do. And so that great resignation could have been playing out alongside substantial costs of various kinds.
Mark Zandi: The discussion so far has really been about the past coming to here, I want to talk a little bit about the future, but before I do that first, we're going to play this. Are you going to play the stats game, Joe, did you want to play?
Jonathon Hazell: I'd love to play the stats game.
Mark Zandi: Okay. We want to play the stats game.
Jonathon Hazell: I'm prepped.
Mark Zandi: Okay, fantastic. But before we do that, let me just, I have cut off Marissa and Cris here. Anything that you guys want to bring up about the conversation so far before we move on to the stats game? Marissa, I'll turn to you.
Marisa DiNatale: Oh, I have so much I could talk to-
Mark Zandi: So much. I know.
Marisa DiNatale: Few hours.
Mark Zandi: All right. Okay.
Marisa DiNatale: I mean, I'll just say I think that the comment about people's perception that their wages haven't kept up with inflation really resonates because every single time I talk to someone, that's the first thing that they say. Right?
Mark Zandi: Sure.
Marisa DiNatale: And then as a labor economist, I say to them, "Well, no, actually, in fact, they have, as of the third quarter, the ECI shows that wages are up 22%, just like inflation is since the end of 2019." But then they always say, "Well, not mine. I don't know whose that is, but it's not mine." The point about the lag is really important because even though that is, I can technically say that's true, wages have kept up. It really just happened in the third quarter that convergence just happened. So while inflation's gone, this wages had to come up. Some of that is just inflation slowing down, so wages could catch up recently. Here's my question.
Mark Zandi: Please.
Marisa DiNatale: This trade-off that you're talking about, people are more sensitive to inflation than they are to unemployment. If you look at periods where you have very high unemployment or you have unemployment rise and you have maybe moderate or low inflation, what is the dynamic that you see there in terms of people's perception of the economy or, yeah, I guess this perception of the economy, how different is it? I mean, I have trouble remembering what that looked like because we've been in this inflationary environment for the past four years. But is it really true that people dislike inflation more than they dislike the potential of losing their job?
Jonathon Hazell: That's a great question. So before I answer, I think just to pick up on something you said, Marissa, which I totally agree with. I think one of the reasons that I like this paper is it's a little bit borne out of talking to real people and not just looking only at aggregate statistics and models. Because I'm guessing I've had the same experience you have where you, the well-informed economist, you charge and you say, "Well, actually you are incorrect and wages are doing great." And it's not a great way to make friends, I guess.
Marisa DiNatale: No, it's not.
Jonathon Hazell: Because people say, this is not my experience at all. And so somehow I felt that one of the things I liked about this paper was to try and leave the ivory tower and look carefully at what people say and try and model that. And often economists try not to do this and say, let's not look at what people say and just look at what they do.
Mark Zandi: Yeah. Interesting.
Jonathon Hazell: But sometimes they really miss things out.
To answer your question specifically about people disliking inflation versus unemployment. A lot of work remains to be done there. I suspect economists and also political scientists will spend a lot of time over the next few years thinking about exactly this question. The fact that I know that is interesting on this is that consumer sentiment, as measured by the Michigan Consumer Sentiment Index seems to correlate much more strongly over the last few decades in the time series with inflation and unemployment. This is very surprising.
It's not what I would've expected, but it is the fact, as I understand it, Larry Summers has a paper which shows that if you adjust inflation, so you add in housing costs in I think a more plausible way than it's done in the basic inflation measurement, this correlation is even more in favor of inflation than unemployment, which is to say a measure of inflation that includes proper measures of housing costs, like mortgage rates and so on, which the baseline inflation measure doesn't. That measure of inflation seems to predict consumers, well-being much better than unemployment, but it's a time series. So in the end-
Mark Zandi: You should you try The Conference Board survey, have you tried that?
Jonathon Hazell: So this is based on me just eyeballing.
Mark Zandi: Oh, okay. Because I bet you get a different result. I bet [inaudible 00:47:29].
Jonathon Hazell: Okay. That's interesting. So like I said, saying this-
Mark Zandi: Yeah. Yeah.
Jonathon Hazell: I did want to say a caveat to the people disliking inflation more than unemployment, which is that the losses from unemployment are very concentrated, but the losses of inflation are quite diffuse.
So you might think that for the 5% of people who get unemployed, their losses from unemployment are plausibly far, far bigger than the losses that everyone suffers from inflation. But in a survey like The Conference Board or the Michigan Consumer Sentiment survey, everyone has one vote as it were. And so there's no way to say, "Well, look, the 5% whose lives are ruined by unemployment should be weighted X times more than the 95% who dislike inflation." My fear is that maybe there is something about the difference between aggregating person by person versus waiting by how bad the experience is.
Marisa DiNatale: Yeah, that makes total sense, right? Because buying eggs, but not everyone gets unemployed.
Jonathon Hazell: Exactly. But more expensive eggs is less bad than being laid off as well.
Marisa DiNatale: Right, Right.
Jonathon Hazell: Yeah. Yeah.
Mark Zandi: Well, let's move on because I do want to get to the future, but before that, let's play the game. The stats game, we each put forward a stat. The rest of the group tries to figure that out with clues, questions, deductive reasoning, the best stat is one that's not so easy we get it immediately, one that's not so hard but we never get it. And if it's apropos to the topic at hand, inflation, all the better. But it doesn't have to be. And Joe just, we always go with Marissa first. It's tradition. So we'll let her go first. Marissa, you're up.
Marisa DiNatale: My stat is 89.2.
Jonathon Hazell: Index?
Marisa DiNatale: It is an index, yep.
Mark Zandi: Did it come out this week?
Jonathon Hazell: This week.
Marisa DiNatale: Yep.
Mark Zandi: Is it from the University of Michigan survey?
Marisa DiNatale: Yep.
Mark Zandi: Is it present conditions?
Marisa DiNatale: No.
Mark Zandi: 89.2 because it's low. It was low. It came in another low.
Cris deRitis: Republicans.
Mark Zandi: Oh, Republicans. Oh, yes.
Cris deRitis: Is that it?
Marisa DiNatale: Is Republicans expectations index, which rose 27.8% between before the election and after the election.
Mark Zandi: Joe, I'm just telling you that University of Michigan survey, I don't know.
Marisa DiNatale: Mark, I think this goes to exactly what we're talking about. If we had listened to the University of Michigan survey, we would've correctly predicted the election. Right?
Jonathon Hazell: Yeah. Yeah. Yeah. Yeah, exactly. I mean, I am not saying it's not crazy, but it could be both crazy and correct.
Marisa DiNatale: Yeah. I mean, I think this gets right to point about the election.
Mark Zandi: Wait. That's the title for this podcast.
Jonathon Hazell: Sure, sure.
Marisa DiNatale: Crazy and correct.
Mark Zandi: Crazy and correct.
Jonathon Hazell: Crazy and correct. No, it's a fascinating stat.
Mark Zandi: Crazy and correct. Write that down somebody.
Jonathon Hazell: Yeah. And Marissa, the decline in Democrats is slight smaller.
Marisa DiNatale: That's right. Democrats declined 17.7 points.
Mark Zandi: Oh, geez.
Marisa DiNatale: And there was a paper, I think it was by Paul Krugman, he did more than a few months ago at this point. But he was talking about Michigan and he was talking about how there's this asymmetry between the way Republicans view a Democratic president and the White House versus the other way around. Right? Republicans punish a Democratic president more than Democrats punish a Republican president in this survey in terms of their perceptions of the economy. And this is exactly how you see it. So now the Republican expectations for the future are the highest that they've been since October of 2020. I mean, this is the biggest jump that I can find in this data series. And this is just the election, right?
Mark Zandi: Oh my God.
Jonathon Hazell: It a big jump.
Mark Zandi: But Joe, that bring up an interesting point though. I mean, this whole pain around inflation could be just simply politics.
Jonathon Hazell: Yeah, absolutely.
Mark Zandi: This is how I view things based on my political prison, has nothing to do with anything else.
Jonathon Hazell: Sure. No, that's absolutely possible. I mean, I think it's a fascinating stat. There are a few, actually, using the 2016 and 2020 versions of this, there are a few academic papers that were documenting that I believe in 2016, my co-author, [inaudible 00:51:42], he shows that the Republican Democrats split was a very strong predictor of subsequent consumption. So people really live these expectations. So it's not just partisan cheerleading or maybe that's part of it, but it's also the case that after 2016 Republican and Democrat spending patterns, investment patterns, mutual fund investments, all diverge dramatically too, which is fascinating. So people really believe this
Mark Zandi: Social media platforms.
Jonathon Hazell: Social media platforms. Exactly. Jonathan Parker at MIT Sloan shows that using, I believe, Vanguard data, that [inaudible 00:52:19] reallocations for Democrats versus Republicans were very significant, which is crazy. They were really changing their stock market allocations in 2016 because of a stat like this.
Mark Zandi: Wow. Crazy, but correct. Okay, we're going to remember that. Joe, you're up. What's your stat?
Jonathon Hazell: Okay. So my stat is 6.4%,
Mark Zandi: 6.4%.
Cris deRitis: Inflation related?
Jonathon Hazell: Sort of. Sort of.
Cris deRitis: Sort of.
Jonathon Hazell: The ballpark,
Mark Zandi: Labor market related?
Jonathon Hazell: Not really. Not really.
Mark Zandi: Not really. Okay.
Jonathon Hazell: As a percent of GDP, let me say that.
Mark Zandi: Oh, 6.4%.
Cris deRitis: Deficit?
Mark Zandi: Oh, is that the-
Jonathon Hazell: Yeah, deficit.
Mark Zandi: Oh, there you go.
Jonathon Hazell: It's the full year deficit of 2024 as a percent of GDP. That's $1.83 trillion. And I wrote it here as a stat because I wanted to ask you this. It's a bit of a mystery to me why deficits were so high last year because the major stimulus of the Biden administration was the American Rescue Plan, whose effect should long since have been passed. And the Inflation Reduction Act, which was at least as scored in 2022, approximately deficit neutral. So what I'm just totally confused about is why deficits remain very high potentially on ongoing basis. And this is not something I've been able to find out much about. So I'm not sure if this is something that any of you know about, but it's a mystery to me anyway.
Mark Zandi: Well, spending levels are elevated, right?
Jonathon Hazell: Yeah. Sure.
Mark Zandi: I mean, despite all the efforts to rein it in around that debt limit battle in 2023, that didn't happen. So we've seen as a share of GDP expenditures remain very elevated. And tax revenue has not increased despite the strong economy. It's not increased. And that goes to the tax cuts, right?
Jonathon Hazell: I see.
Mark Zandi: The Trump tax cut.
Jonathon Hazell: So it's a combination of entitlement spending growth and the GCGAs long shadow is that?
Mark Zandi: It's not less entitlement. Some of that obviously on Medicare, Medicaid, cost of healthcare, but it's also just discretionary spending is up pretty much across the board. Defense, non-defense, everything is up.
Cris deRitis: Interest payments.
Mark Zandi: Oh, and now that's the other thing. Interest. Yeah. So the primary deficit is what? I don't even know. That's probably closer to three point half to 4%, something like that. But still that's large in a full employment economy.
Jonathon Hazell: It is a little worrying. It's very high.
Mark Zandi: A little worrying? I'd say a lot of worrying going forward. Oh, that was a good one, Cris, good job. See. Cris is so understated. If I had gotten that, I'd have been jumping up and down saying how great I was.
Jonathon Hazell: Very impressed.
Mark Zandi: Not Cris. Not Cris. Cris up.
Jonathon Hazell: [inaudible 00:54:55].
Mark Zandi: Yeah. Yeah. Oh, Cris, you're up. We'll do one more.
Cris deRitis: I'm up? Okay. I'm going to give you a lighthearted statistic to take off some of this tension here. $58.8 cents.
Mark Zandi: That's the cost of a Thanksgiving dinner.
Cris deRitis: It is. How much?
Mark Zandi: Okay, Joe. Joe, I'm just now-
Jonathon Hazell: That was amazing. Remarkable. It was so quick. It was like a gunslinger.
Cris deRitis: What was the increase over last year?
Mark Zandi: Oh, that's an interesting question.
Marisa DiNatale: Is it down? Is it down from last year?
Cris deRitis: Well, you tell me. Was that your guess?
Jonathon Hazell: That's what I seem to remember.
Marisa DiNatale: I think it might be down.
Mark Zandi: Well, maybe flu. Doesn't that affect turkeys' avian flu? I would think.
Marisa DiNatale: Yeah, probably.
Mark Zandi: So I'd say it's up 5%.
Cris deRitis: Marissa's, right? It's down 5%.
Mark Zandi: Oh wow. Why?
Cris deRitis: And, it's down 9% from 2022.
Mark Zandi: Why is it down?
Cris deRitis: Turkeys. Turkey prices are down.
Marisa DiNatale: Oh, food prices.
Mark Zandi: Oh, despite avian flu, they're down. Okay.
Cris deRitis: I think the turkeys-
Marisa DiNatale: Turkeys have been scared.
Mark Zandi: They don't have avian flu?
Cris deRitis: Last year or so, and then this year the turkeys.
Mark Zandi: Oh, oh, I see, I see.
Cris deRitis: Interesting. But what I read was both supply and demand for turkeys is down.
Mark Zandi: Both supply and demand?
Cris deRitis: But the demand was more.
Mark Zandi: Okay. Okay. Interesting.
Cris deRitis: There's also a shift.
Marisa DiNatale: I'm not doing Turkey this year.
Mark Zandi: There you go. There you go.
Cris deRitis: You're not? What are you doing?
Mark Zandi: Me neither.
Marisa DiNatale: Seafood stew.
Mark Zandi: I didn't get an invitation to your Thanksgiving dinner. Could I get one?
Marisa DiNatale: Totally untraditional.
Jonathon Hazell: In my limited understanding of Americans, this is far out on the [inaudible 00:56:27].
Mark Zandi: It is far out. Well, yeah, Marisa's a little weird. I'm just saying.
Marisa DiNatale: Yeah.
Mark Zandi: Yeah, we all know that. It's a little weird. Well, I'm having Iranian. Persian.
Marisa DiNatale: Nice. Very nice.
Mark Zandi: And Cris, you're having Italian?
Cris deRitis: I am. Well have some pasta.
Marisa DiNatale: So see, no one's having Turkey on this [inaudible 00:56:49].
Mark Zandi: Except Joe. Joe's having Turkey.
Jonathon Hazell: I'm just going to go to the office and work.
Mark Zandi: Joe's going to cook.
Marisa DiNatale: Joe's British.
Jonathon Hazell: I'm probably going to have a sandwich.
Cris deRitis: Make it a Turkey sandwich.
Jonathon Hazell: Yeah. Maybe. Maybe.
Mark Zandi: There's two things forward-looking I want to talk about. One is President Trump and his policies and what that might mean. But before we get there. One of the key increasing, I don't want to say concerns, but things that are in back of people's minds is inflation doesn't feel like it's all the way back into the bottle. That if you look at core inflation as measured by the consumer expenditure [inaudible 00:57:30], I think we're 2.5%-ish and we need to be closer to two. Is that a concern for you? Is that a big deal? Is this, so-called last mile going to be traversed here? Or how are you thinking about that?
Jonathon Hazell: I think 2.5% inflation doesn't seem like a big deal. It's a problem we would've killed for really at any point in the last 25 years. So 2.5% doesn't worry me. My lingering concern is exactly what we were speaking about before, which is that if you have a persistent or permanent deficit that is in a five to 6% range, that's very, very high. So if that's going to last forever. Perhaps that's leading to 2.5 To 3% inflation forever. And that does seem a little concerning. So a couple of years of above target inflation, it doesn't seem like a problem, but if you just have permanently high deficits and that's leading to permanently high inflation, if we think there's a deficit to inflation link, which I've persuaded myself of, I would be worried about. Yeah. So like I said, I worry about just the persistence of this all if there's just persistent deficits and persistent inflation as a result.
Mark Zandi: Joe, that brings up an interesting question. It just didn't honor me. I mean I always thought of your work as the change in the deficit affects inflation.
Jonathon Hazell: Absolutely.
Mark Zandi: The change in inflation. Is that right? Okay.
Jonathon Hazell: No, that's exactly right.
Mark Zandi: The levels don't matter really, or they might matter.
Jonathon Hazell: But I think it's compl...
Mark Zandi: This is complex. Yeah. Yeah.
Jonathon Hazell: So the way I would think about it is somehow starting from a baseline when deficits are normal, so like two or 3%, and perhaps that seemed consistent with 2% inflation. Starting from that baseline, the change. The shock is like a world where now deficits are always double that. And I would think that would have some effect on inflation. Now it's going to be very sensitive to exactly what your favorite model of the world is. But just intuitively, if the federal government is always running quite big deficits, you would expect that to show up in inflation.
Mark Zandi: Yeah, I guess, it goes back to your point about monetary policy depends on-
Jonathon Hazell: Oh, for sure, for sure.
Mark Zandi: The Fed is going to get 2% if it wants 2%, even if you got a 6%.
Jonathon Hazell: Yeah, exactly. So then the concern is that if the federal government is permanently running these big deficits, what does it mean for monetary policy in the context of interest rate costs and debt? Is there potentially a risk about the erosion of monetary policy independence? This seems very concerning. One thing that I feel pretty confident in is that having monetary policymaking independent of government is good. And 6% deficits, a constant injection of demand into the economy, a constant risk of fiscal dominating monetary. That seems worrying. I'm not worried about slightly high inflation per se. I'm a little worried about what it could signify for the future.
Mark Zandi: Yeah. One other perspective on that, and I just want to get your reaction, is that the principle reason why inflation is above target, say we're at two and a half now and target is two, is the cost of homeownership. The so-called owner's equivalent rent. That's still remains elevated. It's moderating, but very slowly for lots of different reasons. And if I exclude OER, owner's equivalent, I'm there and then some, the inflation is below target. So does that resonate with you or does that make a less worrisome that that's the case?
Jonathon Hazell: Yes and no. The stylized fact from the last, all the US business cycles is that rent is the main cyclical component of the inflation index. I mean, there's some services too, but that's the main finding. Whether or not I am comforted by the fact it's all in rent, depends on why you think rent is the most cyclical component.
One reason could be that rent's easier to measure than other components of inflation and you think there's some underlying cyclicality and rent's a good way to measure it because the way that the Bureau of Labor Statistics measures healthcare and inflation is pretty hard, pretty unclear what it's doing. Whereas the way it measures rent inflation I think is very clear and easy to understand and likely to be correct. So there's this question about whether or not you think that rent is just a good proxy for the cyclical component of inflation, or you think that there are rent specific issues that we shouldn't worry about too much. And I would say the jury's still out on that. I haven't seen a really sharp analysis that says that the rent stuff is all just housing factors only.
Mark Zandi: Okay. Okay, very good. Let's move on and we'll end with President Trump and his policies. And of course there's a lot of uncertainty here, a lot of script to be written. But if you look at or listen to what he said on the campaign trail, and I think we need to take him roughly at his word, at least directionally, he's not going to impose the tariffs or deportations he's talked about on the campaign trail, but he's going in that direction. So we get tariffs that are meaningful. China in particular, but I was in the Europe last week and the EU is quite nervous. UK less so, EU much more so about the tariffs, particularly Germany on vehicles. We're talking about some deportation, we're talking about tax cuts, talking about deficits in debt that probably will add to deficits in debt despite increased tariff revenue. And you mentioned fed independence, that does feel like that might be under some pressure here as well, given what President Trump has said on the campaign trail. You add all of that up. I come to a place where it just feels like all else being equal, that's inflationary. It's some combination of inflation and the higher interest rates and diminished growth. So with that as a preface, let me just throw it back in your court and get your reaction to all that.
Jonathon Hazell: So let me first say before I dive into this that now I'm going a little bit off-piste, so this is absolutely not my [inaudible 01:03:19].
Mark Zandi: You're going off what?
Jonathon Hazell: Off-piste.
Mark Zandi: Piste?
Jonathon Hazell: It's a skiing metaphor. So when you're skiing, maybe this is only a European thing specifically. So when you're skiing on the slopes, you might be on the groomed piste. I go off into the woods. And when you go off into the woods it's a little bit more uncertain.
Mark Zandi: And would you call it piste?
Jonathon Hazell: So maybe this is a European. So we call the piste the groomed slope, and then the off-piste is the bit that's not groomed where everything.
Mark Zandi: Did you guys know that? Did you know that?
Marisa DiNatale: No.
Mark Zandi: Cris knew that. Cris knows that. Cris knows most of this stuff. You knew that, right Cris?
Cris deRitis: Of course.
Mark Zandi: Of course.
Marisa DiNatale: Of course.
Jonathon Hazell: Well let me say maybe off the beaten track.
Mark Zandi: Okay. Okay, now I'm with you. Now I'm with you now.
Jonathon Hazell: Yeah. Yeah. Yeah. Exactly. For my American cousins, I'll say that.
Mark Zandi: Yes, I'm with you now. Okay. Go ahead.
Jonathon Hazell: And so I'll caveat that these are now just my conjectures, but something I have thought about a bit. Okay, so before I get into what I think of them, I think there were four planks to Trump economic policy. The first is likely some large tax cut, either renewal of the TCJA or perhaps even bigger corporation tax cuts. The second is tariffs. The third is a risk of loss of independence of the Federal Reserve. And the fourth, which is related to the first three, but maybe I think useful to be conceptually distinguished is permanently higher deficits.
Mark Zandi: And you did say you're not going to bring in deportations immigration policy?
Jonathon Hazell: And deportations is the fifth.
Mark Zandi: Okay, you are. Okay,
Jonathon Hazell: Excellent. No, no, no. I should mention that too. So let me go through all of them one by one because actually I think each of them is usefully different. So firstly on the tax cuts, this is something that, other than it's facts on permanent deficits, which I'll get to, I think I'm not worried about the inflationary effect of corporation tax cuts. My reading, the academic literature, TCJA, a bit of introspection, suggests to me that corporation tax cuts are to some extent working on supply as well as demand. So they're unlikely to be that inflationary. Which feels like an obvious point, but not a point that I hear raised that often. So now there's excellent micro evidence about the effects of the TCJA.
Mark Zandi: Can I just say this for the listener? That's the Tax Cuts and Jobs Act. That's what was passed under Trump.
Jonathon Hazell: Yeah. Absolutely.
Mark Zandi: Just so they know, just so they know.
Jonathon Hazell: No, no, no, I should always know. No, you're totally right. So actually I am a stickler for not using acronyms, which I've unfortunately-
Mark Zandi: No worries.
Jonathon Hazell: I've violated that rule here. No, it's never use acronyms. So the Tax Cuts and Jobs Act, which is also easier to, say of 2016, a big corporation tax cut, there's now great micro evidence by a couple of people. So this guy Pat Kennedy at UCLA, and a team based at Harvard and Chicago Booth, and they independently find that it had quite big effects on investment, which is what you would expect because it's a big subsidy to investment.
Now whether or not you think this is a good policy, it's going to boost the supply side of the economy. That's what investment does. And there could be some inflationary effects, but you wouldn't expect them to be that big relative to maybe a classic demand stimulus, something like giving people stimulus checks.
There's a long time series of literature in economics that also looks at the effects of corporation tax cuts in the economy. And again, they don't seem to have big effects in inflation. So Planck one is renewed or even greater corporation tax cuts for inflation. I'm not that worried about that. The second is tariffs. And again, this is slightly out of consensus, but I'm also not that worried about the effects of tariffs and inflation. And I would cite two pieces of evidence. The first, just looking back at some fairly sizable tariffs in pre 2020 inflation didn't change very much.
It's also the case that I think the best evidence on Brexit, so from my home country suggests that for all the problems that may have arised due to Brexit, it wasn't a big contributor to inflation. So food and grocery prices seem to have risen a little bit, but they're a relatively small part of the overall consumption basket. So overall consumer prices didn't rise that much after a very big tariff and non-tariff barrier shock in the UK from Brexit. So I've updated towards thinking tariffs are probably a bad policy for other reasons, but probably not very inflationary.
Then the three things that I am worried about, well, first, Fed independence, I think I just have a a strong prior, and I think quite a lot of historical evidence is that monetary independence is just an excellent thing for keeping inflation at bay. And it seems likely this could come under threat. So I think this is very bad. I think basically all economists think this. I think that sometimes economists overstate what we do or don't know about the world, but I actually think just our evidence less from theories, but just a careful read of all of the history suggests that central bank independence is really good. So that I'm worried about.
Fourth is maybe permanently higher deficits. We've discussed, this already doesn't seem like a good idea. It seems like it potentially relates to the third thing, because as Cris was saying, well if you have permanently higher deficits that maybe is going to raise interest rate costs and debt by a lot. And that's the point at which maybe the government leans on the central bank to keep interest rates low, to prevent a spiraling deficit and that's the thing we might think would lead to inflation.
And then finally, the fifth thing is deportations. And here I think it's complicated. And in my mind I'm still a little bit confused. And the reason I'm confused is I think it depends a lot on the time path of how these deportations would work out, how big they are, but also how long it takes. The massive increase in immigration in the US from 2022 onwards, it's big, but I haven't seen yet credible estimates that suggest that it was a big contributor to inflation because it's big, but it's a relatively slow moving effect. And at least for now, the academic consensus is that immigration doesn't tend to have very big effects on wages. That is a whole debate that's rife with debates. But for now, academics seem to think that immigration doesn't have big effects on wages. And the immigration doesn't have big effects on wages, then you wouldn't expect to have big effects in inflation.
Now, I think maybe that evidence could be revisited at some point. But most of the papers that I've read say, "Look, immigration is unlikely to have big effects on wages." And so in the flip side, deportations would be unlikely to have big effects on wages too, but we'll see there. I think the micro level evidence about immigration and wages, I think it has lots of problems, potentially lots of publication bias issues. And so the jury's out on that last one.
So to sum up, I'm definitely worried, not really about corporation tax cuts and tariffs, but Fed independence and permanent deficits do seem to me to be big concerns.
Mark Zandi: So if you look at the bond market, take a look at five year break even. So I look at the yield on the five-year Treasury bond and I compare that to the yield on a five-year Treasury Inflation-Protected Security. So compensated for inflation risk, that so-called difference or break even is a window into what investors, people who put money where their mouth is on inflation over the next five years. And if you go back a couple of months ago, can you say mid-September, when Harris was winning in the polls in the betting markets and compare that till now, obviously she lost and Trump won. Those break evens are up almost 50 basis points, 0.5 percentage points. So the markets seem to be saying, and of course there's a lot of moving parts here and I'm maybe reading too much. There are other things may be going on here, but it feels like a pretty clean read that it's about half a point. Does that sound about right to you?
Jonathon Hazell: Yeah, I mean, so bear in mind that's half a point every year for five years, right?
Mark Zandi: Yeah, that's a lot.
Jonathon Hazell: It's a lot. It's a lot.
Mark Zandi: It's a lot.
Jonathon Hazell: I guess my out of consensus would be less worried about inflation.
Mark Zandi: Less worried about that. Okay.
Jonathon Hazell: But this is something where I would actually want to look carefully at the whole range of data. So one thing that I've learned is there's lots of different data sources and inflation expectation and one wants to carefully look [inaudible 01:11:27]. So first, sometimes probably not for something [inaudible 01:11:30], but sometimes the difference between breakevens and swaps inflation can be very big. That'll be the first thing.
The second thing is my colleague, Ricardo Reis has this wonderful work looking at the whole distribution of markets, expectations about inflation, not just the mean outcome, but is the tail risk of a big inflationary or disinflationary event rising. And to me, I imagine a lot of it would show up maybe as tail risk that there's a meaningful chance of some unanchoring event. So I would want to look at that too. My sense would be that the mean expectation is less bad than the market fears, but there is some tail risk of something really bad happening. That would be my slightly out of consensus relative to the market take.
Mark Zandi: Great. Great. Well this was a fantastic conversation. I really enjoyed it and learned a lot from it, so I really appreciate that. And thank you for all the really good work and thank you for including us in your work. That was very kind of you.
Jonathon Hazell: Of course. I mean, I thank you. I mean, it a really nice chat. Lovely to chat to the three of you. And I'm so grateful because I have a paper now and hopefully one day it will get published somewhere and it was possible I was able to look at this great data from Moody's, so.
Mark Zandi: Well in the notes to the podcast, if you're interested, we'll definitely link to [inaudible 01:12:43] that you, both the papers that you gave to us and any others that you think are appropriate.
Jonathon Hazell: Excellent. That's really, really kind. It's always great to have a platform to speak about research.
Mark Zandi: Thank you. And I had thought you were in the UK and this was late on a Friday, but thank you for doing this on a Friday afternoon. Oh, actually Friday morning where you are.
Jonathon Hazell: No, no, no. It's for me. It's a pleasant mid-morning. Here in Palo Alto, it's all good. Seriously, a real pleasure. So thanks to the three of you.
Mark Zandi: Anything else, guys, before we call this a podcast? Cris, anything?
Cris deRitis: Thank you Joe.
Marisa DiNatale: Yeah. Thank you.
Mark Zandi: Yeah. Thank you Joe.
Dear Listener, thanks for listening. I hope you enjoyed the conversation and we'll talk to you next week. Take care now.