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Mastering the Macro Shift

Mastering the Macro Shift

  • The "good macro" era of steady growth and low inflation is over. A new set of economic realities is taking shape.
  • Economist Philipp Carlsson-Szlezak, Chief Global Economist at BCG, challenges businesses to rethink their assumptions about "good macro."
  • How to navigate tight labor markets, evolving debt dynamics, and persistent inflation.

If it feels like the news is constantly warning of impending doom, you're not alone. Recession fears, inflation anxieties, geopolitical tensions — it's enough to make any investor feel like they're navigating a minefield.

As Philipp Carlsson-Szlezak puts it, "The airwaves are dominated by doomsayers who predict the end of times regularly."

As the Chief Global Economist at BCG and the co-author of Shocks, Crises, and False Alarms, he's spent years analyzing economic trends and advising businesses on how to navigate choppy waters.

While Philipp acknowledges the challenges of the current climate, he doesn't buy into the doomsday narrative. He points out that for a while, businesses got comfortable with "good macro" — steady growth, low inflation, and easy access to capital. But that era is shifting.

"Global macro demands more vigilance, demands a lot more engagement by executives and investors," Philipp says. "But there's lots of good things that are still working well for those operating in the global economy."

Kevin Coldiron and I invited Philipp to another Ideas Lab edition of Top Traders Unplugged to dig into those "good things" and explore how companies can adjust their strategies to win in an uncertain economy. Here are just a few highlights.

The labor (un)comfort zone

One of the most significant shifts in the "good macro" landscape is the rise of what Philipp calls the "era of tightness." "The era of tightness refers predominantly to the labor markets," he explains. "It's when the unemployment rate drops below a so-called neutral rate of unemployment. Essentially, labor is quite scarce."

This scarcity of labor is creating challenges for many businesses accustomed to easy access to a readily available workforce. But Philipp argues that this "tightness," while uncomfortable, can actually be a powerful catalyst for innovation and productivity growth. "When firms can't hire the labor they want, they're first nudged and later forced to embrace technology, and that moves their production functions to the frontier."

He points to the auto industry as a prime example of the dangers of failing to adapt. During the COVID-19 pandemic, many automakers anticipated a prolonged economic downturn and canceled their semiconductor orders. "They went to the back of the line," Philipp notes, "when instead of a really long recovery time, they got this very aggressive recovery with spiking demand for automobiles." The result? Crippling semiconductor shortages and production bottlenecks.

A shift towards a more technology-driven approach has the potential to unlock significant productivity gains over the long term. As Philipp points out, there are other benefits to this new era: "[An era of tightness] comes with a lot of good things, including wage growth, particularly at the bottom of the distribution."

The debt dilemma

Government debt often evokes fear and anxiety, conjuring up images of economic collapse and financial ruin. But is the situation truly as dire as many headlines suggest? Philipp Carlsson urges a more nuanced perspective, drawing on historical context to debunk the prevailing debt anxieties.

"The entire framing of debts in terms of levels is dangerous and tricky," he cautions. Fixating solely on the size of the debt, without considering other crucial factors, can lead to misguided conclusions. He points out that the trend of stimulating economies through debt has been growing for decades, going as far back as the Reagan era, despite the Republican party's claims of fiscal responsibility. This "culture of stimulus," as he calls it, has added both fiscal and monetary tools to the mix, with the "Fed put" becoming a classic reaction to even minor economic weakness.

A new fiscal reality

But the economic environment is changing. Philipp draws a crucial distinction between existential stimulus — the necessary measures taken to prevent systemic collapse in times of crisis — and tactical stimulus, which he characterizes as more frivolous attempts to “juice the cycle."

"Existential stimulus is the ability of policymakers to backstop the system in moments of true peril," like the 2008 financial crisis or the 2020 pandemic, he explains. And this ability, he argues, isn't going away. Financial markets and political will are likely to support such interventions when truly needed.

However, tactical stimulus, the kind used to address minor economic dips, faces more constraints when inflation is a growing concern. Philipp notes that market forces, sometimes referred to as "bond vigilantes," may step in to push back against excessive spending and debt accumulation.

He cites the example of Liz Truss's short-lived government in the UK, where plans to boost the economy through borrowing were quickly met with resistance from bond markets. While he believes the U.S. has a higher tolerance for debt due to its reserve currency status, the risk of a market backlash is still greater in an environment of rising inflation.

The R v. G equation

To understand why debt levels alone don't tell the whole story, Philipp introduces a critical concept: the relationship between nominal interest rates (R) and nominal growth rates (G). "The question is: Is it easy or hard to carry that kind of debt level?" he asks. And that comes down to two variables: the nominal rate of interest compared to the nominal rate of growth."

When the nominal growth rate (G) is higher than the nominal interest rate (R), a country can manage its debt burden more effectively, even at higher levels. "If my nominal rate of growth is higher than my nominal rate of interest, I can carry a very high level of debt," Philipp explains. "In fact, if the spread is favorable, my debt to GDP ratio will fall."

To illustrate this point, Philipp points to Japan: "I think about Japan. And you've had economies at much lower levels of debt — like below 70% and 60% — with a sovereign debt default." Despite having one of the highest debt-to-GDP ratios in the world, Japan has not experienced a debt crisis, thanks in part to a favorable R v. G scenario.

The lesson for investors? Don't get caught up in the debt fearmongering. Instead, focus on understanding the bigger economic picture, including the dynamics of growth and interest rates.

The inflation puzzle

Inflation is a specter haunting boardrooms and household budgets alike. But before we spiral into a panic about runaway prices, it's crucial to understand the nuances of this complex economic phenomenon.

Philipp Carlsson cautions against lumping all inflation together. "We need to differentiate between cyclical and structural inflation," he emphasizes. "[Much of the commentary] has gone off the rails over the last few years because we weren't willing to differentiate between the two."

Cyclical v. structural: understanding the difference

Cyclical inflation refers to short-term fluctuations in prices, often driven by temporary shocks to the economy. Think supply chain disruptions during a global pandemic, a sudden surge in energy prices due to geopolitical events, or even a shift in consumer spending patterns as we saw during the COVID-19 lockdowns. Central banks, like the U.S. Federal Reserve, typically address this type of inflation through adjustments to interest rates, aiming to cool down an overheating economy.

Structural inflation, on the other hand, is a more persistent force rooted in the underlying dynamics of the economy. It's influenced by factors like demographics, technological change, and the long-term credibility of monetary policy. Philipp points out that structural inflation is "determined by inflation expectations." In other words, if businesses and consumers believe that prices will continue to rise in the long term, they're more likely to accept higher prices in the present, creating a self-fulfilling prophecy.

Decoding inflation for business decisions

While cyclical inflation has grabbed headlines in recent years, Philipp argues that structural inflation remains largely under control. "If you look carefully over the last few years, inflation expectations stayed firmly anchored," he notes. This means that despite the recent price volatility, there's no evidence of a broad-based shift towards a 1970s-style inflationary spiral.

This distinction between cyclical and structural inflation is critical for investors making portfolio decisions. For example, if you believe the current spike in commodity prices is primarily cyclical, you might be hesitant to increase your exposure to commodities, anticipating a potential price correction as supply chain issues ease. However, if you believe we're experiencing a more persistent, structural shift towards higher inflation, increasing your allocation to inflation-hedging assets like commodities or real estate could make sense for a long-term portfolio strategy.

The key takeaway: Don't just react to the headlines. Take the time to understand the forces driving inflation. As Philipp suggests, "In the 2020s, it's quite plausible that more often you're going to be somewhat above [the inflation target], and you're going to have to sort of bring it down." This means we should expect a more volatile inflation environment, where agility and informed decision-making will be critical to navigating the inflation puzzle.

The new playbook for "good macro"

The economic landscape is changing. The "good macro" environment that many businesses have come to rely on is evolving, presenting both challenges and opportunities.

Labor markets are tight, pushing companies to innovate and embrace new technologies. Debt levels are high, but understanding the dynamics of growth and interest rates is essential to assessing true risk. And while inflation remains a concern, the ability to differentiate between cyclical and structural forces is crucial for making informed strategic decisions.

The future belongs to those who can read the signals, adapt their playbooks, and embrace the new rules of the game.


This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.