Listeners of Inside Economics have been demanding a podcast on the nation’s debt, and now they have it. At least one side of it. We talk deficits and debt with Paul Sheard, former Chief Economist of S&P Global. To Mark and team’s surprise, Paul explains why he isn’t worried about the nation’s fiscal trajectory. More views on this to come.
Listeners of Inside Economics have been demanding a podcast on the nation’s debt, and now they have it. At least one side of it. We talk deficits and debt with Paul Sheard, former Chief Economist of S&P Global. To Mark and team’s surprise, Paul explains why he isn’t worried about the nation’s fiscal trajectory. More views on this to come.
For more on Paul Sheard's book: Click Here
Follow Mark Zandi @MarkZandi, Cris deRitis @MiddleWayEcon, and Marisa DiNatale on LinkedIn for additional insight.
Mark Zandi: Welcome to Inside Economics. I'm Mark Zandi, the Chief Economist of Moody's Analytics, and I'm joined by my trusty cohosts and another colleague, Cris deRitis, Marisa DiNatale, Matt Colyar. Matt Colyar.
Matt Colyar: Ding, ding, ding.
Mark Zandi: It's impressive, man, isn't it?
Matt Colyar: [inaudible 00:00:35] a little hesitation, but sure, it's good.
Mark Zandi: Well, come on. I'm an old man. It takes me a while to figure it all out, but I got it right, right? Colyar?
Matt Colyar: Yes. Yeah, you did. That was good. Yeah.
Mark Zandi: I think I said this last time, you know how I now know how to pronounce your last name?
Matt Colyar: The Florida geography [inaudible 00:00:50].
Mark Zandi: Yeah. Colyar County.
Matt Colyar: Yeah.
Mark Zandi: Naples. Naples, Florida. Yeah, and I saw Marisa this past week. Yeah, we were at Phoenix for the Moody's Summit. That was very good. Very enjoyable couple of days. We also have an outside guest. Let's bring the outside guest in right away. Oh, Paul, I realize, I don't really know, I could be screwing up your last name Sheard. Is it Sheard?
Paul Sheard: It's Sheard. It rhymes-
Mark Zandi: Sheard.
Paul Sheard: ... with beard-
Mark Zandi: Okay.
Paul Sheard: ... which I no longer have.
Mark Zandi: Say that again?
Paul Sheard: It rhymes with beard, which I-
Mark Zandi: Oh, beard.
Paul Sheard: ... no longer have.
Mark Zandi: Okay. Sheard. Okay, I'll remember that for... Well, it's good to have you on board.
Paul Sheard: Thanks very much for having me, Mark.
Mark Zandi: Yeah, and we're going to talk about, well, of course, the inflation statistics that came out this week, but the real reason we have you on is because we want to chat about deficits and debt. There's a lot of interest out there among the listeners with regard to how to think about our growing deficits and debt. Of course, you've been thinking about that issue globally for a long time, but before we dive into any of that, can you just give us a little bit of a bio? I was just commenting before we went on, when I was reading your history, it feels like you've been the Chief Economist of almost every financial institution on the planet at some point. I think I have that right.
Paul Sheard: Yeah. Well, there are two or three, maybe four, not quite sure. Yeah, so I hail originally from Australia. I'm Australian-American now. First half of my career was as an academic in Australia, Japan, a little bit in the U.S., and then about 1995, I moved into the financial markets. Spent about five years on the buy side in Tokyo, and then I moved in 2000 to Lehman Brothers in Tokyo. I was Asia Chief Economist then Global Chief Economist. Moved to the U.S. in 2006.
Of course, my tenure with Lehman Brothers was somewhat interrupted in September 2008, and then I transitioned through Barclays through Nomura Securities as their Chief Economist, but based in New York. Then, I moved in 2012 to S&P, Standard & Poor is now known as S&P Global. I guess the rating agencies sort of keep quite hermetically sealed from one another, so we overlapped very little, obviously was very little-
Mark Zandi: I know.
Paul Sheard: ... [inaudible 00:03:16]. I think we did this over at a couple of conferences, and then I left in 2018, sorry, 2018, and then I spent about four years at Harvard Kennedy School, mainly working on this book, if I can give that a plug-
Mark Zandi: Oh, cool.
Paul Sheard: ... Power of Money-
Mark Zandi: Power of Money.
Paul Sheard: ... which has a little bit about debt in there as well, so that's a thumbnail sketch of yours truly.
Mark Zandi: I'm so sorry. I didn't know you had a book out. What's the thesis of the book?
Paul Sheard: Well, it's all about money, sort of how money comes into existence, monetary policy, fiscal policy, and just everything about money. Sometimes money goes wrong and you have financial crises. A little bit about the Lehman failure in the book as well. Throw my six pennies' worth into that debate, and a chapter on inequality and international aspects of money. It's kind of like from a markets perspective, somebody who spent 25 years in financial markets kind of aimed at a general audience that wants to understand some of these more technical issues rather than just jumping into the river and everybody's talking about quantitative easing and all this other stuff and they don't really know how it works. I try to unpack the nuts and bolts a little bit.
Mark Zandi: Very cool. When did you publish the book?
Paul Sheard: May of last year.
Mark Zandi: Okay. Yeah, so was that a difficult thing writing the book?
Paul Sheard: It was a bit of a labor of love, but as you know-
Mark Zandi: Labor of love.
Paul Sheard: ... writing a book takes quite a commitment, hard work, but I'm glad I did it.
Mark Zandi: Yeah, I describe it like running a marathon. It's like, "Why am I doing this again exactly? What's going on?" Then, you get across finish line, not that I've run a marathon, but I'm just saying.
Paul Sheard: No, neither have I.
Mark Zandi: I do a fair amount of running, but I've never run a marathon, but I know when I'm out there mile five, I'm saying, "What am I exactly... Why am I doing this?" But-
Paul Sheard: I find it easier to write books than run marathons, I have to say.
Mark Zandi: Very good. Well, congratulations. That's fantastic, and I'll definitely go read it. Did you go into digital currency, Bitcoin?
Paul Sheard: I have a chapter on digital currencies as well.
Mark Zandi: You do? Okay. Yeah, I'm very curious-
Paul Sheard: Kind of-
Mark Zandi: ... about that. Yeah, very-
Paul Sheard: ... basically saying, "Look, interesting innovation. Probably going to become a permanent part of the asset ecosystem, but every unlikely, almost impossible to upend the sovereign monetary system that we're used to."
Mark Zandi: Mm-hmm, although it is funny you say that because I was in a cab coming from Phoenix Sky Harbor into the resort and talking to the fellow, the cab driver. A very interesting fellow from the Middle East, and he was railing about, "You guys, you Americans are ripping us off with that Dollar. What's the value behind the Dollar? I mean, it's just a piece of paper." You know? So-
Paul Sheard: Mm-hmm.
Mark Zandi: ... yeah, but you explain that.
Paul Sheard: Yeah, I talk a little bit about the reserve currency status, what a reserve currency is and whatnot, so most of those topics are in there one way or another.
Mark Zandi: Cool. Cool. Okay. Well, it's good to have you on board and I can't wait to get to all the deficit and debt conversation. Oh, and do you speak Japanese? You were-
Paul Sheard: Mm-hmm.
Mark Zandi: ... you were on a Moody's conference call with Stefan on Japan. You speak Japanese?
Paul Sheard: Yeah. I lived in Japan for 17 years and actually published a couple of books in Japanese, so-
Mark Zandi: Oh my goodness.
Paul Sheard: ... and Mark, a lot of my perspective on money and deficits and particularly quantitative easing, because the Bank of Japan kind of invented that, trace back to my experience in Japan. Being in Japan in the 1990s/2000s when the Bank of Japan was doing all of this stuff, deflation, a lot of concern about the fiscal deficits was kind of an advanced training ground to think about these issues before they all kind of went global in 2008 and beyond.
Mark Zandi: Well, we're definitely coming back to the Japanese, the way they're handling deficit debt because I can't quite get my mind around that, but so we'll come back to that. Before we do that, we're going to talk about the key statistic of the week, and that was consumer price inflation, CPI. We also got PPI, producer price inflation, and import/export prices today, so a lot of inflation data. To help us kind of understand what the data said, is saying, what the messages here is Matt Colyar. I am really old, like-
Marisa DiNatale: He's only worked here for like five years, so [inaudible 00:07:57].
Mark Zandi: I just call him Matt. I just call him Matt.
Matt Colyar: That works.
Mark Zandi: Yeah. To give us the rundown, so Matt, you want to give us the rundown on the CPI, PPI, anything else you think is important?
Matt Colyar: Sure. I'm curious if you agree with the characterization that inflation's progress has sputtered a bit in 2024. I don't know if it's-
Mark Zandi: I think that's a factual statement, yeah.
Matt Colyar: ... sure. February, the headline CPI, the consumer price index, rose 0.4% from the month before, which is a little bit hotter, a little bit stronger than what we projected, what consensus expectations were, which was 0.3%, which would've been the same as January's increase. The annual rate went from 3.1% year over year to 3.2% in February. We can break down more of the components, some of the big ones.
Mark Zandi: Let's get right to the crux of the matter, and it feels like it's still the cost of shelter, the growth and the cost of shelter. I mean, there's lost of other things going on, but that feels like that's the reason why inflation hasn't really come back to the Federal Reserve's target. In fact, I was looking at CPI consumer price index ex shelter, I think year over year. I think it's-
Matt Colyar: [inaudible 00:09:22].
Mark Zandi: ... below 2%, you know?
Matt Colyar: Yeah, 1.8 is-
Mark Zandi: Yeah-
Matt Colyar: ... in February.
Mark Zandi: ... and if I look at Core CPI ex shelter, so I know I'm ex-ing things out, but just for the sake of argument, core being food and energy prices and that we will tend to look at core to get to the underlying trend. Throughout shelter, we're at 2.2%, something like that year over year. We're there is the point... Oh, exclude, though, just the one part of shelter, the owner's equivalent rent. The part that's related to homeowners evaluating the implicit rent they pay. You exclude that, which would put it on kind of a harmonized basis with many other ways other countries and the way they measure CPI inflation. We're at, I think, 2%. We're there, right?
Matt Colyar: Mm-hmm.
Mark Zandi: Am I wrong? Am I right? What do you think?
Matt Colyar: No, you're right, and I know Cris has this week wrote some interesting stuff on our website about that topic and because of how that owner's equivalent rent has come under such scrutiny because it is what's kind of propping up core CPI and CPI in the U.S. Yeah, you exclude housing, you exclude shelter owners equivalent rent, and you're where the Fed wants to be, but the Fed can't certainly communicate that, "Okay, we're going to stop worrying about that," so it really is imperative for that figure. However, it's calculated, as you know, to come down. It's what we forecast. That's why we're still relatively optimistic about where inflation's headed, but it has been frustratingly slow and then February was no different there.
Mark Zandi: Yeah, so Cris, I mean. I know you mentioned you've been doing a deeper dive. Every month we do, you seem like you go down another thousand feet in the ocean to figure out what the heck is going on here. Pretty soon, maybe they'll give you the spreadsheets they use, the BLS will give you the spreadsheets this year.
Cris deRitis: I would love that.
Mark Zandi: Yeah, I would, too. Now, what you're thinking, why is shelter costs owners equivalent rent particularly being, although last month it was rent of shelter that was where we saw an acceleration. What's going on? Anything you learned recently about that?
Cris deRitis: Maybe just reinforcing some of the things we talked about in the past in terms of just the difficulty in measuring owner's equivalent rent. Conceptually, I think it makes sense. It's a nice idea. You're trying to capture this cost of shelter services, cost of housing services, but in practice, the way we try to estimate what a homeowner is getting out of their home and the cost of that shelter that they're getting, it's just very difficult. Trying to infer what a homeowner's cost of shelter is from other renters in the area, just very difficult for a variety of reasons, not least of which is just their segmentation in these markets. Trying to look at the rental housing population, even if we look at just single-family detached rentals and trying to make an inference of what that means for the owner-occupied market just doesn't work because you have, again, very distinct markets.
The owner-occupied part of the market may be higher end housing. The rental housing may be more affordable, and so looking at those growth rates and trying to adjust for observable characteristics just... I see it as a very fraught exercise, and for that reason, I'm becoming more and more of a fan of the Harmonized Index of Consumer Prices. Just ignore owner's equivalent rent, accept that there are difficulties in measuring it, and just focus on the rent that we can observe and the other prices, of course.
Mark Zandi: Now, this has been a problem for all of time. It's not like this is a new problem, so what has changed in the current context that's complicated things, that's keeping the OER, the owners' equivalent rent, and cost of shelter high compared to actual market rents? If you look at actual market rents from pick your place, Zillow, Apartments.com, rents have been flat to down for more than a year. They're going to be flat to down for another year giving all of the supply coming in. What's causing this disconnect? Do you have a sense of that?
Cris deRitis: I see it as just the extreme tightness of the market that we have today. It's just... You're right, this has always been a problem, but BLS has changed their methodology to try to address some of the issues in capturing or making these estimates. It was a big revision or a big change in 1983, for example. For the most part, as long as the housing market is in range, it's been a question of lags, just a little bit stronger inflation perhaps due to shelter in some periods, a little weaker in other periods, but nothing major. Unlike what we're seeing today, which I view is tied directly to the fact that we have this record low level of housing inventory. We have very little affordable housing available and that is causing or juicing up the rents that we see for that part of the market. When we do this extrapolation, it just gets enhanced, if you will, in the owner's equivalent rent portion.
Mark Zandi: Paul, I'm going to come back to you in just a second. I'm going to bring up this so-called "immaculate disinflation argument," which it bothers me to no end, but I'm going to throw it back to you. Before I do that, I going to come right back to Matt because since we're in the weeds, if you had to pick another weed to focus on, we picked on the OER, the cost of shelter in this last report, what would that be? What else was in the report kind of in the weeds that was important to call out, do you think?
Matt Colyar: I think goods prices, so we've been able to rely on goods prices coming way down after supply chain constraints in 2021, 2022. Built until a year ago, they're basically flat, but in February, core goods prices ticked up, so it's the first time that prices have increased for core goods since May. It's that support, that disinflation or even deflationary support that goods have been giving to overall CPI is waning.
We forecast out these kinds of things and we expect a sideways movement, so similar to what we saw in February, modest increase, mostly sideways, which means that you're just relying on services now, so you don't have that support. Really, the trend for shelter, the trend for services more broadly, that inflation is going to be clear and center, front and center because there is as much need to be parsing out and to exclude all of the types of things because the inflation we're going to see is labor-intensive services inflation, which has been the Fed's priority for a while.
Mark Zandi: This might be an unfair question, but what percent... but that doesn't stop me from asking, but we'll see. Good test. What percent of the overall CPI or core CPI is what you call core goods prices? I mean, What share of the CPI is that?
Paul Sheard: I'd be guessing, so I appreciate you acknowledging that that's a tough test.
Mark Zandi: Okay. All right, this is what we're going to do. We're each going to come up with a number and we're going to add it... Now, Matt, you can't look. Don't look.
Matt Colyar: Okay.
Mark Zandi: Marissa, what do you think it is?
Marisa DiNatale: What percent core goods is of?
Mark Zandi: What percent of the total CPI is what Matt called core goods? The basic goods that we consume?
Marisa DiNatale: Hmm.
Mark Zandi: One, two-
Marisa DiNatale: 20%.
Mark Zandi: 20%, okay. Cris?
Cris deRitis: Well, goods overall is 35%, right? Services 65?
Mark Zandi: Well, you're including energy in that, too, right?
Cris deRitis: I am. Yeah, so-
Mark Zandi: It's food-
Cris deRitis: ... [inaudible 00:17:24] that out.
Mark Zandi: ... you're including energy and food?
Cris deRitis: Yeah, that's the whole shooting match. Yeah.
Mark Zandi: Yeah.
Cris deRitis: You want me to strip out food and energy?
Mark Zandi: Well, Cris, you got three seconds.
Cris deRitis: Okay.
Mark Zandi: Three, two, one-
Cris deRitis: 50%.
Mark Zandi: ... ooh. What? 50% of the CPI is core goods?
Cris deRitis: No, that doesn't make sense.
Mark Zandi: No, it doesn't make sense at all. You're done.
Cris deRitis: I'm [inaudible 00:17:51].
Marisa DiNatale: You're out.
Mark Zandi: Matt, what do you think it's going to... what are you in?
Matt Colyar: 15% I think if you exclude energy and food is where you'd be, right? About?
Mark Zandi: I was going to say 20. Paul, what were you going to say? I don't want to embarrass the guest, but what were you going to say?
Paul Sheard: Yeah, I was starting with 30, but as I was listening, I was going down to around about 20.
Mark Zandi: There you go. I say 20, but it could be 15. What is it, Matt?
Matt Colyar: Oh, I didn't look it up. I was [inaudible 00:18:13].
Mark Zandi: Oh [inaudible 00:18:16]. All right, we'll come back to you. We'll come back to you.
Matt Colyar: Okay.
Mark Zandi: Okay, Paul. All right, so Paul, here's the thing, and I just got... I don't know if I can tell you the media outlet that just sent me an email writing a piece about so-called "immaculate disinflation." That's the way this slowing and inflation over the past 18 months or so has been characterized, which suggests, I think, that this was unexplainable, that it just kind of sort of happened. No one could have figured this out. No one could have predicted it. It just was immaculate disinflation, which I totally disagree with. In my mind, the surge in inflation back in late '21/'22, early '23, that and the subsequent disinflation, that was lots of factors.
At the top of the list was the pandemic and the Russian War and the supply chain disruptions and the conflation of those things because they happened successively affected inflation expectations and we were off and running. Now, as the fallout from the pandemic and Russian War are now behind us, or there's still residual effects, vehicle prices and even owners' equivalent rent because of the lack of building, but as they go to the rear view mirror, inflation has been able to come in without recession. That's kind of where my mind is. Very curious if you're as annoyed at this phrase, immaculate disinflation" as I am or not. Maybe you coined this, maybe you coined this phrase.
Paul Sheard: No, I'm not going to claim credit for that, Mark, but no, I think I agree with you. We had a big shock to the economy, largely self-induced through the way that the COVID policies were implemented and essentially printing, we'll get to this in a minute with the debt issue, but printing a huge amount of money just sort of necessary to keep the economy on suspended animation through the lockdowns, et cetera. What everybody I think underestimated except a few people was the kind of semi-permanent, at least for a few years, massive damage done to the supply side, particularly the labor market and supply chain. A lot more money constricted supply, you get inflation, and the Fed completely missed that, and so did a lot of people, so did I.
I was writing pieces in 2021 saying, "Don't worry too much about inflation," but two reasons. One is I thought I was to a large extent temporary relative price shifts that would sort of self-correct. I ended all of my op-eds by saying, "But if that's wrong, if we do get elevated inflation, the job of the Federal Reserve is to hike interest rates, tighten monetary policy, and bring that inflation down again, and they will do that." There's a timing issue. How long does it take? In theory, this was always going to happen. Inflation was going to peak. The Federal Reserve was going to tighten monetary policy, inflation was going to come down.
The big question, I think, that you're getting at is, "Well, can all of that be done without the economy going into recession?" In theory, there's absolutely no reason why it can't be done, and I think... but what a lot of people would, perhaps their thinking was colored by two things. One is the historical experience that if you go back and you look, most of the time when the Fed hikes interest rate and tightens dramatically, you get a recession at some point. It's sort of the dirty and easy way of bringing demand back in line with supply, but there's nothing kind of God-given about that.
I think the second thing that was coloring people's views was that, well, if you Fed had made such a colossal error in its own monetary policy and inflation forecasting, which did, go back and look at the forecasts that the Fed had for inflation one or two years ahead. Its own interest rate stance colossally wrong. That's just a fact. It's not necessarily a criticism, but having made that mistake, they then said, "Well, how likely is it that they're able to now get out of that hole, tighten monetary policy, and with all the uncertainties in the system around the lags with which monetary policy works, what is the right terminal rate? 5.25 to 5.5% or 6%?"
The chances that the Fed was able to pinpoint that and get the economy on this glide down to 2% inflation again without tipping into recession, I think a lot of people just thought the odds of that are kind of pretty slim, but from kind of a theoretical analytical perspective, there's no reason why not. The view that says, let me finish here, is like, "What's the theory that's being tested here?" I think a lot of the people who are saying there has to be recession associated with this had some kind of Phillips curve in their head. You got to create some slack to disinflate the economy, but I think that this whole period has been a pretty good test of what you might call the inflation expectations management theory of inflation targeting.
That's a real mouthful that basically says the key to central banks being able to achieve their inflation targets is their credibility in the eyes of the public as inflation targeters, which means they have to anchor and manage the public's inflation expectations. One thing that has been very notable through this whole four-year period now is that inflation expectations have remained pretty well-anchored around the Fed's target. In other words, when inflation spiked up to 5, 6, 7, 8%, that the public's inflation expectations did not ratchet up with them. If they had, that maybe would have put you in a world where the Fed would have to prove, "We're really dead serious about this. If it takes a recession, Volcker-like, we'll do it." They never had to go there because inflation expectations remain very well-anchored. It could still happen, but I'm not sure it's an immaculate... What did you call it? Immaculate-
Mark Zandi: Immaculate disinflation.
Paul Sheard: ... disinflation.
Mark Zandi: Yeah.
Paul Sheard: It's something that central banks should be able to pull off and it looks like the Fed is actually doing it.
Mark Zandi: Yeah, you said a bunch of stuff there and it's hard. I don't think we can have time to unpack it all, but one thing you said where you were talking about inflation back in 2021 and you thought it was temporary, and of course, it ended up lasting longer, he made it sound like you made a forecast error. I would argue against that as well because how could you have forecasted a Russian war in Ukraine and the impact that had on oil prices, natural gas prices, agricultural prices, other commodity prices? I mean, it felt like to me we got hit by two shocks that were kind of one right after the other. The reason why inflation wasn't as transitory as we thought it was after the first shock is because we got the second shock. That was not even on the radar screen-
Paul Sheard: That one would have to be-
Mark Zandi: ... until February 2022.
Paul Sheard: ... yeah, that one you'd have to be some kind of geopolitical genius to have forecast that, but a lot of the inflation was the initial post-COVID kind of response up until February 2022 when the invasion happened. If we talk to that bit, again, I would put myself in the category of people that underestimated the damage that had been done to the supply side of the economy. Demand collapsed with the COVID lockdowns about 10% in two quarters, then it bounced back very quickly and fiscal and monetary policy did their job in putting enough money into the system to keep demand up and ready to come back when the lockdown sort of dissipated. One number that I focused on ex post, I didn't note at the time so much, we saw this incredible data all over the place. Unemployment going from 3.5 to 14.7 in two months between February and April 2022.
That should have been a bit of a clue, but a number that was available, but I'd focus on enough, was the number of people not in the workforce. It's not a statistic usually most people look at, but that went February 2022 from 95 million, April, that was 103 million, so in the space of two months, 8 million people told the statisticians, I guess, "We're out of the labor market." Well, that number never normalized. It came back to about a hundred million and it's still around about a hundred million today, so 5 million people kind of taking it... This is the Great... What do they call it? The Great Retrenchment, The Great-
Mark Zandi: [inaudible 00:27:19].
Paul Sheard: ... Retirement, The Great Disappearance of the workforce, but that bit of it, I think if the Federal Reserve and macroeconomists had been a bit more... had more supply side expertise in their toolkit rather than being macroeconomists focused on forecasting demand probably would have bought that bit a little bit earlier.
Mark Zandi: Yeah, agreed, agreed. Looking forward, now the debate is, will inflation close that so-called "last mile?" That we're kind of hanging around 3% CPI inflation, core PCE deflator inflation, that's the consumer expenditure deflator the Fed looks at for setting its target, it feels like that's somewhere 2.5 to 3 and it has to be a 2 to hit the Fed's target. That's the last bit here. What's your sense of that? Do you think that's going to close here over the next, well, foreseeable future? What's your sense of that?
Paul Sheard: It should, but I gave an interview on the floor of The New York Stock Exchange, I think it was towards the end of last year, and I sort of quip on the way out. It wasn't on tape, but I said, "I wouldn't be totally surprised if the next move from the Fed is upwards because there's nothing magical about 5.25 to 5.5%." The theory is that's enough monetary tightening to put into the system that it gradually inflation will decelerate down to where inflation expectations are well-anchored. If the economy and agents in the economy sort of shrug it off and say, "Well, I feel pretty good, unemployment's low, yeah, inflation's coming down, that's good," and again, all of that money that was put into the economy, when I talk about money here, I'm not really talking about the Fed's quantitative easing. I'm talking about the printing of money that came through budget deficits.
That money is still in the system, and so there's a lot of purchasing power in this economy. It's a very productive economy, but there's a lot of purchasing power. The question really is, what's magical about 5.25 or 5.4% on the interest rate on reserves that the Fed has set? Again, I'm not forecasting it, but one shouldn't be... I think there's a little bit of perhaps too much complacency in the forecasting last year saying, " Well, Fed's," let's face it, Mark, we economic forecasters, market forecasters, tend to take a cue off the Fed.
The Fed says, "We've got 3 or 400 PhDs in economics and econometrics, we're stopping at 5.25 to 5.5 percent, inflation's coming down," there's a tendency to say, "Well, yeah, that's the peak level." The question is, when do they start cutting? Is it sooner? Is it later? Everyone seems to be pushing back now, but again, I would not be totally surprised if we got a rate hike.
Mark Zandi: Well, Paul, I think that's where I'm going to part company with you in terms of the Fed. It feels like to me they've achieved their goals. The full employment, the sub 4% unemployment rate, rock solid two years-plus, wage growth's been coming in gracefully. It feels like full employment. Inflation, we talked about that. I think outside of the shelter costs were there. Inflation expectations, as you pointed out, they're nailed down or they're locked down. Financial conditions, it feels like they're roughly where they should be.
Of course, stock market's up, but the bond yields, mortgage rates are up. Credit spreads are narrow, but lending by banks is constrained because of the banking crisis, so I think they're kind of roughly where they need to be. Kind of add it all up, all the things that go into the so-called "reaction function" the Fed uses, it feels like we're there, so why do we need a 5.5% target? Unless you think the so-called "equilibrium rate," the R-star is a lot higher than what the Fed things it is, which is at 2.5%. Just curious how you'd respond.
Paul Sheard: Yeah. No, again, I wouldn't argue against any of that, but all I'm saying, and most likely the next move is down maybe second half of the year, but I just wouldn't given the strength [inaudible 00:31:57]-
Mark Zandi: Oh, I see.
Paul Sheard: ... and if you get a bit of irrational exuberance coming into the economy again, consumption, et cetera, surprising on the upside, I don't think the Fed unpicks the PCE and says, "Well, we're there because this component's unusually high.
Mark Zandi: Mm-hmm.
Paul Sheard: My point is simply that I think we should be a little bit agnostic about this and the kind of... This one, if I was managing money and sort of advising a portfolio team, I'd be saying, "Let's run a scenario where the next move from the Fed is actually 25-basis-point hike or something." Not beyond [inaudible 00:32:37]-
Mark Zandi: Oh, I got it, I got it.
Paul Sheard: ... [inaudible 00:32:38].
Mark Zandi: You're saying that my baseline is, "Okay, it feels like they're going to start cutting rates here in the next few months, but I wouldn't be surprised there's a scenario with a reasonable probability that, in fact, they're going to have to start raising interest rates." The economy-
Paul Sheard: It's-
Mark Zandi: ... [inaudible 00:32:52]-
Paul Sheard: ... almost... yeah, that's right, and it's sort of a corollary of that immaculate disinflation that you talked about, that this is going so well and if people kind of feel that and that money that has been injected into the economy just starts to get released into purchasing power. Given a lot of the labor market numbers have kind of normalized, but as I said, there's a few that I think job offering is still pretty high still. The labor market looks pretty tight, so you could get another forecasting error from the Fed, which is, "Gee, the economy is turning out to be much more resilient. We just need to perhaps just dial up a little bit one more time just to make sure that everybody gets the message, "Hey, cool down a little bit here."
Mark Zandi: Yeah, got it. I think that's called the no landing scenario that we don't really land and we sort of take off again and-
Paul Sheard: Right, right.
Mark Zandi: ... passive response.
Paul Sheard: You mentioned R-star, that one become this popular kind of term, and everybody jumped on the R-star bandwagon and remembered like Wicksell and all this stuff. Again, we were told a few years ago the robots are coming and all the jobs are going to be wiped out, and here we are with this 500-basis-points hike in or 525-basis-point hike in the Federal Funds Rate, and still this very, very strong labor market. I don't know, maybe the natural rate of interest... No one's got a clue what it is really. Let's face it, the Fed in its forecasting, a lot of it is kind of adaptive forecasting. Who says the natural rate of interest, which nobody can observe, is really only 0.5%. Maybe it's 2%.
Mark Zandi: Yeah, yeah, yeah. Right. You mean on a real basis 2%?
Paul Sheard: Right, yeah.
Mark Zandi: Yeah-
Paul Sheard: Yeah.
Mark Zandi: ... so nominal would be 4-ish or 4.5, something like that. Yeah.
Paul Sheard: Yep.
Mark Zandi: Yeah. Yeah, yeah. Yeah, that is a very-
Paul Sheard: I just think again, there's more mystique in this Fed watching and inflation forecasting and forecasters tend to hug the Fed. I guess I've got a disproportionately contrarian streak in me, so I like to say, "Hold on a minute, maybe [inaudible 00:35:11].
Mark Zandi: I hear you. It's definitely higher than 2.5. It's just a question of what. In our official, in our baseline forecast, we have 3 as the nominal 3, but 4, yeah, maybe, but I still go back to where 5.5, that's still... and if you've achieved your goals, but you make a point that won't parse the data I just did, even though I think they should. They're not [inaudible 00:35:34] they won't parse it that way.
Let's play the statistics game. The game is we each come forward with a statistic that the rest of the group tries to figure out through clues and deductive reasoning and questions. You don't want a stat that's so easy that we all get it, and you certainly don't want one that's so hard that we never get it. If it's apropos to the topic at hand, that would be great. The goal here is to come up with a state that Marisa can't get, so we'll all work on that one, but before we get there, Marisa, as tradition has it, you are the first person to go here on the game, so what's your stat?
Marisa DiNatale: Okay, this is hard because I had a lot to choose from that I want to do, but I'll choose this one because it makes a point. 4.5%.
Mark Zandi: Inflation related?
Marisa DiNatale: Yes.
Mark Zandi: From the CPI report?
Marisa DiNatale: Yes.
Mark Zandi: Is it year-over-year inflation for some component of CPI?
Marisa DiNatale: It is year-over-year inflation. Yeah.
Mark Zandi: Of some component?
Marisa DiNatale: Mm-hmm.
Mark Zandi: Oh, okay. Okay, so 4.5%, guys?
Matt Colyar: Supercore?
Marisa DiNatale: Yes.
Matt Colyar: Aah, of course.
Mark Zandi: Aah, supercore you said? Supercore?
Matt Colyar: Yeah.
Mark Zandi: Okay.
Marisa DiNatale: Yep.
Mark Zandi: You want to explain?
Marisa DiNatale: Sure, so this is services inflation excluding energy services and shelter. We've been talking about how shelter is the next leg down, the final leg down in inflation, but actually supercore has been moving upward on a year-over-year basis since September every month steadily. Even when you take out shelter from services and even when you take out energy services, there are other services that have actually been moving up. Now, we talked about how big shelter is as a share of inflation. This is smaller, but economists like to look at supercore because it kind of goes to wage inflation because these are services where the biggest part, the biggest cost within these services that business have are the wage bill, the wage they're paying workers. This has been moving upwards, so my point is it's not just shelter that's been coming in hot.
There are other components within services that have been moving up, and I'll give you an example, and I hope I'm not taking anybody's statistic, but this is something I looked at for myself the other day. Auto insurance is up almost 21% over the year. It's up 40% since before the pandemic, so if we go back to February of 2020, car insurance prices are up 40%. They're up 21% just in the last year. I got my new auto insurance policy the other day, so I decided to look at it, and mine was up 26% over the year. There's medical insurance has been rising, medical costs have been rising, the cost of pharmaceuticals have been rising, so there's other stuff going on that I want to make sure is on our radar other than just shelter.
Mark Zandi: Yeah, I got my insurance bill, too. When I got it, I go... I got an email from the insurance company and I see the... Well, first of all, my wife got it and she goes, "Mark, you have to pay a rental insurance." My daughter has an apartment and you got to pay rent. I go, "Oh, okay." That's usually like a hundred bucks, and I look at it's almost, I'm not even going to tell you what the number was, but it was thousands of dollars.
Marisa DiNatale: Really?
Mark Zandi: I go... I nearly choked. That can't possibly be the renter's insurance. I go, "No way." I go, "Look, it's my auto insurance."
Cris deRitis: Yeah.
Mark Zandi: Yeah, so it was crazy number, and so I'm going back and forth with the insurance company now trying to... I have gotten it down because now what you do is you go look at, "Well, what am I buying exactly?" You say, "Oh, I don't need that. I don't need that. I don't need that." Anyway, but that goes back just to point it out to the pandemic. All roads lead back because vehicle production collapsed. There were no chips. Global vehicle production collapsed. Inventories evaporated.
New vehicle prices go skyward, so anything related to a new vehicle, including the insurance on that vehicle, is going to see prices rise, with a long, long lag in the case of vehicle insurance and vehicle maintenance. Even there, I'd say, "Okay, the Fed can't do anything about that," but anyway. It was a good statistic, a good statistic. Paul, we'll do one more and then I'll come to you so you can see how we're doing this, and I'll go to Matt. Matt, what's your stat?
Matt Colyar: 0.3%
Mark Zandi: Inflation?
Matt Colyar: Yeah.
Mark Zandi: CPI?
Marisa DiNatale: Month over month?
Matt Colyar: Not CPI and, yes, month over month.
Mark Zandi: PPI?
Matt Colyar: Yes-
Mark Zandi: Oh gosh. Is a component of PPI.
Matt Colyar: ... but not like five digits-
Mark Zandi: Oh, you're saying-
Matt Colyar: ... [inaudible 00:41:01].
Mark Zandi: ... some measure of core PPI, core final demand or something? No?
Matt Colyar: Close
Marisa DiNatale: Core goods?
Matt Colyar: No [inaudible 00:41:15].
Marisa DiNatale: Final goods?
Matt Colyar: Final demand services.
Mark Zandi: Oh, final demand-
Matt Colyar: [inaudible 00:41:18] compared-
Mark Zandi: ... services. Oh, the same ballpark, the same point.
Matt Colyar: Yeah-
Mark Zandi: Yeah, okay.
Matt Colyar: ... and which we didn't talk about PPI. Top-line PPI was up 0.6%, which is a relatively big, scary number, but within the PPI, it's a similar story to the CPI, which was good. Prices aren't falling sharply like they had been and are no longer dragging down overall PPI inflation like they are in CPI, and underneath the hood, services PPI inflation was 0.3%. Not great, but down from the month before and relatively modest, so not a three-alarm fire like the top line number would potentially indicate rising 0.6%, which was twice as fast as the month before and twice expectations. Similar story, goods no longer delivering the deflation/disinflation that they had been.
Mark Zandi: Hey, Matt, let me ask, now that we have CPI and PPI for the month of February, what's our estimate for the consumer expenditure deflator? Core X, food and energy, PCE Deflator, which is what the Fed targets the 2%. What do you expect for the month?
Matt Colyar: The 0.3, which for the headline PC would be same as the month before, and for core it's 0.3 as well, which would be a slight tick down. That's like you said, mapping CPI and PPI components to their relevant PC-
Mark Zandi: O.3.
Matt Colyar: ... counterparts. Yeah-
Mark Zandi: Okay-
Matt Colyar: ... but-
Mark Zandi: ... and then what would that mean? I know I'm pressing, but I'll do it anyway. What does that mean for year-over-year core [inaudible 00:42:53]-
Matt Colyar: It's two weeks out, and the [inaudible 00:42:57] and so I don't have any that would require. It's pretty sensitive to decimal points there, so [inaudible 00:43:00]-
Mark Zandi: Yeah.
Matt Colyar: ... yeah.
Mark Zandi: Okay.
Matt Colyar: That'd be something
Mark Zandi: Okay, fair enough.
Marisa DiNatale: Oh, and Matt, did you look up the, because I did, and I want you to look up what the share of core goods in the CPI-
Mark Zandi: Oh yeah.
Marisa DiNatale: ... is.
Mark Zandi: What was it?
Matt Colyar: I did. I was going to use that as my number. 18.8 is-
Marisa DiNatale: Oh-
Mark Zandi: Way to go.
Marisa DiNatale: ... so you were right-
Mark Zandi: Yeah.
Marisa DiNatale: ... basically.
Mark Zandi: Very good.
Marisa DiNatale: Uh-huh.
Mark Zandi: Very good. Well, 18.8, if you had said 18.8, I would have been really impressed, but I'm just impressed now. Yeah.
Marisa DiNatale: I was, yeah, 1.2 percentage points off.
Mark Zandi: Right. Very good. All right, Dr. deRitis, what's your... Oh no, I was going to go to Paul next. Paul, what's your stat?
Paul Sheard: This is fun,
Mark Zandi: Isn't it?
Cris deRitis: Yeah, it's a lot of fun.
Paul Sheard: I'm going to move away... I'm going to move away... I wish... Yeah, economics can be fun. I'm going to move away from percentages and talk in dollars. This is just kind of a rounding here. $1.5 trillion.
Mark Zandi: Is it related to the deficit?
Cris deRitis: Deficit?
Paul Sheard: Hmm, only very indirectly to the deficit.
Mark Zandi: Oh.
Paul Sheard: Not really.
Mark Zandi: Not really. Okay.
Paul Sheard: Well, I mean, it is, but that's a deeper conversation. It's not a deficit number.
Mark Zandi: Yeah.
Marisa DiNatale: Is it related-
Mark Zandi: It's not around-
Marisa DiNatale: ... to the-
Mark Zandi: ... it's not fiscal-
Marisa DiNatale: ... the balance sheet in some way, Paul?
Paul Sheard: Yeah, Marissa has the golden touch.
Mark Zandi: I told you. She's the goddess here [inaudible 00:44:19]. Fed balance sheet 1.5 trillion, so Marissa, what would that be on the-
Marisa DiNatale: I...
Mark Zandi: ... because the balance sheet is what-
Marisa DiNatale: ... is it how much it's shrunk-
Mark Zandi: ... aah.
Marisa DiNatale: ... in the past.
Paul Sheard: [inaudible 00:44:33] who's going to believe that we didn't collude on this together?
Mark Zandi: Oh-
Paul Sheard: [inaudible 00:44:38]-
Mark Zandi: ... gosh, that is great. Way to go.
Paul Sheard: We talked a lot about the Fed hiking, but of course, we have quantitative tightening going on at the same time, and the Fed's balance sheet peaked at just a tad shy of 9 trillion and it's down to about 7.5 trillion now. With their runoff program, it's sort of shrinking at the rate of about 1.1 trillion per year, so 1.5 trillion is back in the hands of the market.
Mark Zandi: That is so cool. Well done, Marissa. That's really very good. When the Fed start... Do you have, Paul, any expectations around when the Fed's going to end its QT and how it's going to do that? Any [inaudible 00:45:17]-
Paul Sheard: Well, that's a very interesting point, Mark, because the Fed kind of quietly, I mean, the Fed watchers know this, but after the financial crisis and all the QE, QE1, 2 or whatever, did we get up to 3? They shrunk the balance sheet. They didn't go back to their pre-financial crisis operating regime, which would've been a regime of eliminating excess reserves and just targeting the Federal Funds Rate. They implemented a policy called an ample reserves regime, and they stopped the balance sheet unwind at that point, roughly, what was it, around about 3 trillion-ish or so.
Now, if the Fed were to go back to normal, I think their balance sheet would be around about 2.5 to 3 trillion. They're at 7.5 trillion. Who knows where they're going to stop? Probably I'd guess around 4, 4.5 trillion, something like that because they'll continue with this ample reserves regime. Of course, the key here is that the Fed now pays interest on reserves, and so there's no need for them to eliminate excess reserves in order to get their control back again over the Federal Funds Rate. They've got a lot more optionality now between balance sheet management and interest rate targeting.
Before the Fed paid interest on reserves, and this goes for other central banks as well, if they wanted to target the Federal Funds Rate, they had to make sure there were no excess reserves in the system. What that's done is introduce a kind of level of opaqueness into the Fed's balance sheet management because where they finished their QT effectively is an arbitrary point. It's just, "Well, we think it's ample now," but what's that?
Mark Zandi: Right, and just for the listener, QT, quantitative tightening, so they bought a lot of securities to bring down long-term interest rates back in the teeth of the pandemic. Now, they're allowing those securities to run off through maturation and prepayment if it's mortgage security and the balance sheet shrinking, but as you're saying, they're not going to let it shrink all the way back. They have to maintain, as you say, "ample," and that makes it difficult to gauge because it's a matter of judgment, you know-
Paul Sheard: Yeah.
Mark Zandi: ... at that point.
Paul Sheard: By the way, just to plug my book again, if you don't mind-
Mark Zandi: Yeah, yeah.
Paul Sheard: ... Chapter 4 in my book is on QE and QT, so-
Mark Zandi: Qt. Yeah. No. Yeah, I can't wait to read it. Okay. Cris, you want to do one more before we move on?
Cris deRitis: Sure, this is a quick one and a good segue, I think.
Mark Zandi: Yeah.
Cris deRitis: Okay, a hundred days. 100 days.
Mark Zandi: Is that how long it took the treasury to... the deficit to be larger than last year or something like that?
Cris deRitis: Oh, in that spirit-
Mark Zandi: In that vein?
Cris deRitis: ... yep. Amount of time for something to rise by selling out.
Mark Zandi: For the deficit to rise more than a trillion dollars? Or no?
Cris deRitis: For the national debt to rise by a trillion dollars.
Mark Zandi: Oh, for the national debt to... yeah, the national debt to rise. Oh, very cool. Very good. Yeah, why did you pick that? Just in honor of-
Cris deRitis: I don't know.
Mark Zandi: ... the-
Cris deRitis: In honor of-
Mark Zandi: ... [inaudible 00:48:30].
Cris deRitis: ... the topic here. I listen to you, Mark.
Mark Zandi: Very good. Okay. Well, that's a good segue. I have a statistic, but I think we should move on because we played the game to death, and I don't want Marisa to win again, so-
Marisa DiNatale: Mm-hmm.
Mark Zandi: ... we're going to keep going. We're going to keep going. Let's turn to deficits and debt, and just as a frame for folks, obviously, we're running large deficits. I think as a shared GDP, the nation U.S. deficit is about 6%. I think the so-called "primary deficit," so that's excluding interest payments on the existing debt, is closer to 3%. Still very wide by historical standards. The debt load is rising very rapidly. If you go back pre-financial crisis, I think it was hovering 40 percent-ish of GDP. That's publicly traded debt to GDP.
We're now at a hundred percent close to, and according to the Congressional Budget Office, the CBO, the nonpartisan folks that put the nation's budget together, if we have no change in policy tax spending policy going forward, which by the way would include the reinstatement of higher tax rates on high-income individuals because they got cut under President Trump. Those cuts expire at the end of 2025. The debt-to-GDP ratio goes to 115 percent-ish 10 years from now, 180% 30 years from now, and that's when the forecast ends, but you can do your own forecast and obviously it continues to rise.
Paul, with that as kind of the backdrop, first of all, anything you want to add to that to provide context? There's a lot of angst out there. Every time I give a speech, I say, "What's bothering you?" Invariably, this is one of the things that are really bothering people. How do you think about this? How worried are you about our fiscal situation?
Paul Sheard: If I said not at all, that might be a slight exaggeration, but you get the point, and again, I got a chapter in my book about this as well. We all know about MMT, Modern monetary theory. I think it's got a bit of a bad rap. I don't advertise myself as an MMT. I don't like being put in boxes, but I started thinking about this stuff as I've sort of intimated earlier, back in Japan when QE started in 2001 in Japan, had to sort of figure out what's going on with QE and, how does the monetary policy relate to the fiscal policies, et cetera?
I think a lot of the way we kind of think about.. It's like a category error. We call it government debt, and of course, debt means that it has to be repaid. If something is getting bigger and bigger all the time and it has to be repaid, then it sounds like you are on a road to somewhere bad. What I would argue is that what we call government debt, and by the way, just on some numbers here, we're up to 34 trillion. That, of course, is the headline number. If you look at debt which is held by the public, that's 27 trillion because quite a bit of debt is held within the government.
Mark Zandi: The hundred percent of-
Paul Sheard: [inaudible 00:51:43]-
Mark Zandi: ... GDP, the public-
Paul Sheard: ... you worry about is 27.
Mark Zandi: ... yeah.
Paul Sheard: Then, you got a $28 trillion economy as well. Again, there is a tendency in this debate to pick a number and it says, "Oh my God, let's call it 27 trillion." That sounds like a huge amount of money. Well, actually, the U.S. economy is a $28 trillion economy, so it's kind of proportionate to that. The other thing that I don't like is that... we talk about metrics, debt-to-GDP ratio. Everybody talks about that in percent terms. When you say, "Gee, a hundred percent," somehow it just cognitively feels like this is unsustainable.
As you know, Mark, the debt-to-GDP ration, the correct units is number of years equivalent to GDP, so it's a stock over a flow, and the correct unit is... If you said the GDP, the debt-to-GDP ration was a hundred percent, what that tells you is that the stock of debt, government debt, is equivalent to one year's flow of GDP. Just kind of apples and oranges. Getting back to the point that I think the way to think about government debt is it is essentially government-created money, and that's what debt is. It's the cumulative budget deficits.
What a budget deficit does is, the government creates more money than it withdraws or destroys when it withdraws from the economy. It's essentially purchasing power, and if it's held in the form of Treasuries, people who own Treasuries are transferring purchasing power into the future. The question in my mind is not the question of how are we ever going to repay this debt, but rather, is there too much purchasing power being created and residing in the economy relative to the capacity of the economy to produce goods and services now and into the future?
Rising deficits or rising debt is kind of like a race between governments printing too much money and creating too much purchasing power or a lot of purchasing power versus the ability of the economy to innovate and create goods and services at a faster rate. It's not really debt. It's not something that has to be repaid. It's not something that's really a burden on our grandchildren because intergenerationally the stock of debt is both on the asset side and the liability side of society's balance sheet. There are distributional issues obviously associated with it, so the big question is, is it going to be inflationary? If it is, getting back to our Fed discussion earlier, that would mean the Fed is going to have to tighten monetary policy more than it otherwise would have to do.
We've had, of course, an example that we've just been talking about in the first half of the show of what can go wrong when the government is printing too much money relative to the capacity of the economy. You get inflation. Then, we know what happens next. The Fed has to tighten monetary policy. We get a slowdown and maybe you get a recession. To me, that's the biggest issue. Is it inflationary or not so much? Is it some kind of burden on a future generation?
Mark Zandi: That's interesting. That's not what I expected, but I hear you. Just I guess two areas that we can explore. The first is, if the economy's at full employment, and I think we're there, it feels like we're at full employment, sub 4% past two years, that kind of thing. It feels like we're kind of there in terms of what the federal government can do or should do in terms of running these large budget deficits. They run large budget deficits and they're increasing, that means tax cuts and or spending increases.
That's juicing up the economy, going beyond full employment, and creating those inflationary pressures that you said. Let me stipulate. I agree with you, the constraint, the limitation, limiting factor here is inflation. If you juice up your economy with large budget deficits and you generate inflationary pressures, higher interest rates, that's kind of the governor here that ultimately matters, but aren't we already there in the current context?
Paul Sheard: Well, I think that kind of gets back to the discussion we had before that, is the Fed on course to achieve its inflation target? If it is, in the short to medium term, that would kind of imply, well, the kind of government spending we have at the moment is fine. The economy is at full employment, we've got inflation where we want it, and the Fed is regulating demand in the economy appropriately. I think another angle, maybe two angles on this that are related is another issue, of course, is do you want such a big government? There's two ways in which the government, and I think that's the political argument here, rather than the sort of economic argument per se, but-
Mark Zandi: Well, no, there's an economic aspect to that too, right? I mean, you hear that the CBO in its estimates would say that the government is less productive than the private sector all else being equal. Therefore, you don't want to err on the side of big budget deficits. You want to err the side on more balanced budget so the private sector can take more of the government, the economy's resources, and it's more productive that way. That's the argument.
Paul Sheard: Right, right, so that's definitely one of the arguments is so to me that's the more important argument-
Mark Zandi: Okay, okay.
Paul Sheard: ... and that has to be the battlefield for that is obviously the political system, but government-
Mark Zandi: Yeah, so again, though, I mean, for example, you look at infrastructure spending. You go look at the CBO, and I'm just using the CBO because they're viewed to be nonpartisan and nonpolitical, and I think that's true. You look at their studies on infrastructure spending, they'll say that those investment dollars that the government is spending on infrastructure are less productive than the investment dollars the private sector could have used if not for the government taking it for infrastructure. The general thinking is, and certainly it's on the margin, it depends on lots of factors, but generally the thinking is that you want to shepherd the government's resources so you can have more resources for the public sector to invest. No? You don't buy into that?
Paul Sheard: No, I mean, I think that's kind of right in the sense that ultimately, so if the government is doing a whole lot of infrastructure investment, and think about it in terms of these investment dollars, I would think about it more in terms of the government then is commanding real resources in the economy. Those obviously the resources that the government commands are not going to be available for the private sector to command. Then, the question is, so who would you have rather commanding the resources, the government or the private sector? Now, some people would argue, "Well, if it's a private good, you want the private sector. If it's a public good, maybe you want the government doing it more because the private sector is not going to build the bridges and the infrastructure." You get into that sort of argument, but that's one area.
The other area that is kind of glided over a little bit when we have these budgetary discussions and you look at revenues and you look at expenditure breaks down, is the government does two things. It transfers income, and that's Social Security, Medicare. Once that income gets transferred, of course those dollars then get released into the economy and command resources, but there's this other issue of, how big a role do you think the government should have in income distribution?
That has an economic dimension to it as well because economists would say, "Well, the bleeding heart side of me says we should do a lot of that." The government can create dollars instantaneously. It creates too many, it'll get inflation, but it can create the dollars. On the other hand, if you create welfare dependencies, you're going to also probably end up with a less efficient economy, which is not good for anybody in the long run as well. Again, to me, those are the interesting debates, very complicated debates, but too often this debt issue is sort of short-circuited by people saying, "Oh, look at that number, 34 trillion, look at the debt clock. It's unsustainable." I don't think that's the right way to think about it.
Mark Zandi: Yeah. Okay, so just to put it into Zandi's mind, the way you're thinking about it is the deficit debt debate, it shouldn't be a debate about deficit and debt. What it's a debate over is the size of government, the role of government. You mentioned income distribution, but the role of government and also this governor around inflation. I mean, if the government starts running these huge budget deficits in the context of a full employment economy, you got a problem because more inflation, interests are going to rise. You're going to get a recession.
Paul Sheard: Yeah, and that segues. No, that's a great point, Mark, and it segues into another point that I've sort of made for the last few years is that fiscal policy, as we're talking about, can be inflationary and sometimes very inflationary. When you step back and look at the macroeconomic policy framework that we have in the Western world and here in the U.S., we have this separation of monetary and fiscal policy. There's an aggregate demand and inflation control element to fiscal policy, but we don't give that to the Fed. We don't give that to the technocrats. We say, "That's political. That's something that the government has to deal with." We give the Fed the job, although it doesn't have all the tools. It doesn't control a large part of the picture of how that money is coming into the economy.
We give it to the Fed to do, so what I'd argued a number of pieces over the years, a little bit of this is in my book as well, that we need at some point to step back and have a sort of whiteboard discussion about, what does the sensible, optimal framework of macroeconomic policy management, which includes monetary policy and fiscal policy, look like? Shouldn't there be more coordination, communication, and joint responsibility between what we call the fiscal and the monetary arms of that process rather than just under the sort of rubric of what we have to keep monetary policy independent and independent and isolated from political influences? Let's not have that coordination because at the moment, the de facto framework is the fiscal, the politicians, make their decisions about how much spending they're going to do, how much taxing they're going to do, and therefore, net-net how much purchasing power is injected into the economy.
The Fed has to take that as a given and say, "Okay, wow, they're spending too much. That's going to overheat the economy. We're going to have to tighten monetary policy to offset that." There are distributional consequences of that. This argument that says we shouldn't bring fiscal policy under that purview because there's distributional issues and that's not the role of technocrats to worry about that or to weigh in on that. Monetary policy implicitly does have a distributional effect or set of implications. You can't get away from that just by saying, "Well, the Fed is independent of the government." I don't have all the answers here, but I think a debate needs to be opened up to say this is not the best framework in the world that we have at the moment, and how could we improve it?
Mark Zandi: Yeah, although I think that's a really... The Fed's got a complicated job already. I got to achieve full employment and I got to keep inflation low and stable. Pretty hard to throw another objective, worry about the income distribution at the same time. Okay, so I hear you, but that's a pretty tough one. Let me push back a little bit more, though.
Paul Sheard: Sure.
Mark Zandi: The other argument you hear, which I'm somewhat sympathetic to, is that goes to interest payments. Real cash out, and here's the statistics I was going to give you with this big hint I just gave you, so here's the two statistics. Tell me what they are. $860 billion, $775 billion. 860 billion, 775. Go ahead, Cris.
Cris deRitis: I'm going to say one is interest payments and the other is defense spend.
Mark Zandi: Exactly. 775 is interest payments. That's the in the year ending in February of 2024. 860 billion... Did I get that right? Yeah, 860 billion is defense year end, but the trajectory here is that these lines are going to cross here in the not-too-distant future because all you have to do is go back a few years ago and interest payments were half of what they are today. You look out a couple of years from now, maybe even a year from now given the trend lines, we're going to be shelling out as a nation more on interest payments than our own defense. That's never happened in our history. The last time we even came close was back in the '90s, and that's when we made some pretty tough fiscal choices to reign in spending and raise taxes.
Cris deRitis: Yep.
Mark Zandi: The U.S., unlike... I think this is where U.S. and Japan kind of part company, a lot of those bonds are owned by foreign... U.S. Treasury bonds that are issued to finance the deficit are owned by overseas investors. I think about a third of the debt, and we're talking about the Japanese, they may be the largest foreign investor, the Chinese, the folks from the Middle East. These are people who are shelling out, and I think in the case, correct me, you know this much better than I, Paul, but I think the Japanese JGBs are much more owned, there are much fewer owners outside of Japan. These are Japanese households that are effectively buying that debt. Isn't that a matter of some concern here that at some point we're going to be shelling out more on our interest on the debt than to maintain our own defense?
Paul Sheard: Well, I think that's a little bit of apples and oranges, but it's a little bit one of these, again, one of these kind of stark numbers, but you say, "Well, is that really the issue?" There's some kind of race between interest payments and defense spending. By the way, I think I'm correct in saying that if you look at the fourth quarter interest payments number in the U.S. and annualize it, it's now over a trillion [inaudible 01:07:00]-
Mark Zandi: I think it is over a trillion. Yeah.
Paul Sheard: ... basic [inaudible 01:07:02]-
Mark Zandi: Yeah, annualized.
Paul Sheard: ... and so obviously, so that's one of the issues. Now, again, there's the apples and orange bit here is that interest payments are a monetary transfer. The government creates money out of thin air, including the interest payments, and transfers that to the public, so it's money injected into the economy. It's a little bit like a fiscal transfer.
We think of it as a concomitant of monetary policy, so the interest on the debt goes up when the Fed raises interest rates because coupons go up and that's what happens, but it's really kind of a fiscal transfer. That bit of it you could argue is actually kind of stimulatory to the economy, but it goes essentially to the rich people a very low marginal propensity to consume. Again, I would look at that issue more from the viewpoint of not like it's a big number. Yes, it's a big number, but it's really an income transfer to the people who hold the bonds and the bonds there because of prior budget deficits. That money's moved around the system. I don't think there's any intrinsically right or wrong about that number being bigger or smaller than defense spending. I think you could-
Mark Zandi: No-
Paul Sheard: ... [inaudible 01:08:19].
Mark Zandi: ... it's just that's a didactic tool to just drive home-
Paul Sheard: Right, right.
Mark Zandi: ... a point, right? Yeah.
Paul Sheard: I think you could turn it on its head and say, "Is the U.S. spending too much on defense?" I mean, they are real resources and they are resources that are not then available for the New York Subway. Getting back to your car insurance, Mark, my car insurance bill is zero-
Mark Zandi: Right.
Paul Sheard: ... because I live in New York and I don't have a car, but I do worry about the state of the New York Subway, so again, I think we get-
Mark Zandi: Well, what about the point... I think... I'm writing this, at least one third of the payments are not going to American... at least nominally American investors. They're going to the Chinese, they're going to the Saudis. Should that enter into the calculation-
Paul Sheard: I-
Mark Zandi: ... at all? Or not?
Paul Sheard: ... you're right. That 34 trillion, take out the internal debt, you're down to 27 trillion.
Mark Zandi: Yeah.
Paul Sheard: About 8 trillion is held by foreigners-
Mark Zandi: Right.
Paul Sheard: ... so about one-third or so, or maybe.
Mark Zandi: Yep.
Paul Sheard: You mentioned Japan. Japan, that number historically, of course, Japan has relative to the economy a lot more debt accumulated, something like 1,200 trillion yen. It's a mind-boggling number. That used to be typically about 5% or so. I think it's actually moved up. A number I saw recently was more like 15%, even a little bit higher because this portfolio decision that investors are making globally. The way I look at it, particularly when you look at Japan and the U.S. is I like to fall back on the national accounting identity. I'm sure it's bread and butter to you guys as well, but the current account balance is the country's... essentially their net savings rate, if you like, net of investment, and you can split that into private and public.
If a country is running a current account surplus, now Japan historically has run a current account surplus of about 3% of GDP on average over the last 40 years or so, 2.9, something like that. That means that net-net, Japan is actually accumulating claims on foreigners, if you like, lending to foreigners, so it's the government... The government looks like it has a debt problem, but Japan as a country doesn't. The U.S. is very different because it's almost mirror image. The U.S. historically has run a current account deficit of about 3% of GDP. I think that's around about right, roughly 3%.
Mark Zandi: Yeah.
Paul Sheard: Let's say the budget deficit now I was talking about 6% of GDP, something like that, negative.
Mark Zandi: Yep, yep.
Paul Sheard: That [inaudible 01:11:14] the missing component is the private sector is running a surplus, which is covering part of the government's deficit, but not enough to be a net lender to the rest of the world, so cut a long story short, yes, net-net when you take everything into account. The U.S. is essentially importing more than it's exporting, so the rest of the world is accumulating Dollar claims on the U.S. Is that Triffin's dilemma? Is that what the U.S., the price if you like, that the U.S. has to pay to be the reserve currency? Which gives a lot of benefits to the U.S. I think there's some people say, "No, that doesn't follow." I think it more or less does.
If the rest of the world is going to be demanding this safe asset of Treasuries, essentially the U.S. has to be running a current deficit to be a net supplier of Dollar claims. I think when you get into... If you dig into that, then you say, "Well, hold on, that means some money is going from the Treasury to Chinese investors, Japanese investors, Saudi investors." I guess my reaction is yes, but that is the way in which a globalized economy and financial system operates, and I don't think you can just... It almost feels a little bit... I don't want to use the word "racist" or "xenophobic, but it's like to pull out that bit and say, "Ooh, why is money going to the Chinese?" The other-
Mark Zandi: Well-
Paul Sheard: ... thing to bear in [inaudible 01:12:42]-
Mark Zandi: ... I mean, at the end of the day, you understand the argument. You got voting Americans saying, "I'm interested in America." You know?
Paul Sheard: Yeah, but those voting in America-
Mark Zandi: It's xenophobic, but it's reality.
Paul Sheard: ... those voting Americans are also helping the U.S. run a current account [inaudible 01:12:58]-
Mark Zandi: Detro.
Paul Sheard: ... it would be China.
Mark Zandi: Yeah, true.
Paul Sheard: If China is going to have a trade surplus vis-a-vis the U.S., which it still does, whose fault is that?
Mark Zandi: It just makes you... It's not even that. It's like, "Okay, we're now in this pitched battle with the Chinese," the U.S. and China. It's not a commentary, good, bad, or whatever. It is what it is. Chinese own a lot of Treasury bonds and accumulating a lot of Treasury bonds. Feels like... I was going to say it feels like we should be worried about it. Now, on one hand, will the Chinese actually shoot themselves in the foot? That's what they would be doing if they kind of sold or didn't buy or whatever, but on the other hand, push comes to shove, they might. They might use that as a tool because they know it's going to hurt the U.S. as well.
Paul Sheard: Yeah, yeah.
Mark Zandi: It's a vulnerability, right? You're saying that's just-
Paul Sheard: I think in some ways-
Mark Zandi: ... the price for globalization.
Paul Sheard: ... yeah, but I think in some ways they're more vulnerable than we are, and bear in mind that those interest payments that go to the Chinese because they're holding Treasury debt are Dollar interest payments that they have to deploy in the U.S. economy or find somebody else through the foreign exchange markets who is prepared to hold those Dollars instead of the Chinese, which means going into euro or yen or Aussie dollars or Kiwi dollars. You rapidly run out of big liquid number two, number three, number four reserve currencies that China can offload those Dollars into. Ultimately, that purchasing power that the Chinese are getting their dibs into is purchasing power that's going to have to be released back into the U.S. economy at some point.
Now, it does mean that maybe our grandchildren, I don't know what sort of factories they're going to be working in in the future if the robots have not completely taken every job, but they're working in some factory. They're churning out products, electric vehicles or solar panels or whatever we're producing in that period, and some of that stuff will be going to Chinese consumers rather than American consumers. Then you ask yourself... Again, you talk about voters, but do our grandchildren care too much about that or are they more interested in having a job and working for a company that's selling and shipping product out the door? Of course, all of that is the reversal on the flip side of the current generation today, importing a lot more from China than we're exporting to them. THat's sort of the intergenerational transfer bit, but it's a little bit more subtle than just the debt being a burden on the grandchildren.
Mark Zandi: I just looked at the clock and I had to go, "Oh my gosh." We've been chatting a while, and we're running out of time, but one quick question. Is there any... Assuming that fiscal policy is running in a way that we're not generating inflationary pressures, and is there any kind of fiscal situation, deficit debt or any other measure you want to use where you'd say, "Okay, this is a problem," or not? Could we be Japanese, like have a-
Paul Sheard: Yeah.
Mark Zandi: ... 225% debt-to-GDP ratio no problem?
Paul Sheard: Yeah, absolutely. I mean, should be able to blow through Japanese numbers because the U.S. is the reserve currency-
Mark Zandi: Okay, okay.
Paul Sheard: ... but what would you worry about? I think what you would worry about is a breakdown in the institutions, a loss of confidence in the Dollar and the institutions that produce the Dollar. Underlying all of everything that I've said is this implicit assumption that the Fed is there, it's independent, it will do its job, and it can do its job. It might mean if you get too much fiscal spending you're going to end up with a higher R-star in some sense. That would be one thing that too big a government, too much intrusion, too much spending might push that R-star up that natural rate of interest.
In any case, cyclically, the Fed will have to raise interest rates higher as a cyclical peak to quell inflation, and that will have all sorts of impacts on all these invisible people that we don't even think about. People are going to pay the price for that, so it is an issue to think about, but if we moved into banana republic territory and you had a breakdown of the institutions and at some point people said, "Wow, I don't trust these jokers, I'm losing confidence in the fabric, the social contract almost," then, you get into... Again, another one of the underlying assumptions, Mark, is that we are prepared to deal in Dollars and to hold Dollars. You've mentioned your taxi driver in... was it Atlanta or Phoenix?
Mark Zandi: Phoenix, yeah, I was in Phoenix. Yeah-
Paul Sheard: That is-
Mark Zandi: ... so my hometown.
Paul Sheard: ... that is the scenario in which cryptocurrencies and whatnot come into play that people... Oh, yeah, Argentina and Dollarization of the economy, but I think we're way, way, way, way away from that kind of scenario.
Mark Zandi: Very interesting. Yeah, I knew you knew a lot about this and had thought about it deeply, but I didn't know where you stood, so I am surprised, but very fascinating discussion. I think I'm going to hear from the listeners and they're going to say, "Bring the other side of the conversation on," but I thought it was very interesting, very fascinating, the way you thought about it and framed it. One last thing, you want to give us the title of your book again? So-
Paul Sheard: Oh yeah, sure, so if you can see it, The Power-
Mark Zandi: The Power of Money.
Paul Sheard: ... of Money: How Governments and Banks, Create Money, and Help Us All Prosper. It's a kind of positive spin. Wall Street gets a lot of beating up. Money helps the world go round. We didn't have money, we wouldn't have this thriving economy producing $28 trillion of goods and services. I opened the book with a quote from Hobbes. That's how we'd be miserable and whatnot without money, but it's a bit of a primer on money and how it all works and what's the right way to think about it.
Mark Zandi: Cool, because I remember... Was this the same Hobbes that said, "No man's an island unto themselves?"
Paul Sheard: Probably. Probably.
Mark Zandi: Probably.
Paul Sheard: I'm talking about the Leviathan Hobbes.
Mark Zandi: Oh, the Leviathan Hobbes, yeah. Right, right. Okay. Well, so good to have you on, Paul. I really appreciate you taking the time, and I think, guys, we've taken our fair share here. We better move on, so dear listener-
Paul Sheard: Thanks, Mark. Economics hasn't been this much fun for a long time.
Mark Zandi: Oh, that's a real endorsement. We'll have to put that somewhere on a tweet or something, or one of those on X or LinkedIn or something. I appreciate that, and with that, dear listener, we're going to call it a podcast. Talk to you next week.