Why the Economy is Vulnerable to Recession ft. Claudia Sahm

[00:00:07] Claudia

lf it were going to break, it’s this time. We’re in this tricky place of, you don’t want to use the rules of thumb, use the rules of thumb, this time is different, be careful, we’ve gotten burned, this time is like every other time that really gave some bad insights. But then as we get further and further away from some of the very unusual features of the cycle, well, then some of those more usual rules of thumb, you might want to pay attention to them. We don’t quite know what to trust.

[00:00:43] Intro

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Here’s your host, veteran hedge fund manager, Niels Kaastrup-Larsen.

[00:01:39] Niels

Welcome and welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is the series that I not only find incredibly interesting, as well as intellectually challenging, but also very important given where we are in the global economy and the geopolitical cycle.

We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macro-driven world may look like. We want to explore their perspectives on a host of game-changing issues, and hopefully dig out nuances in their work through meaningful conversations. Please enjoy today’s episode hosted by Alan Dunne.

[00:02:23] Alan

Thanks for that introduction, Niels. Today, I’m delighted to be joined by Claudia Sahm. Claudia is Chief Economist at New Century Advisors and also the founder of Sahm Consulting. She’s also the author of the Stay-At-Home Macro Substack. She’s probably best known for her recession indicator, the Sahm Rule.

She was previously director of macroeconomic research and senior fellow at the Jain Family Institute, and prior to that director of macroeconomic policy at the Washington Center for Equitable Growth, where she advised Congress on the CARES Act. Earlier in her career, she was an economist and section chief at the Federal Reserve Board and also was a senior economist at the Council of Economic Advisers. So, Claudia, great to have you on today. How are you?

[00:03:08] Claudia

Great to be here. Thank you.

[00:03:10] Alan

Good stuff. I went through all the main points of your background, but we always like to start by just getting a bit of a flavor from our guests as to how they got involved in their respective fields. So what got you interested in economics and how did you end up in your current position?

[00:03:29] Claudia

I was extremely fortunate when I went off to college, to a liberal arts college, Denison University, to have the most amazing economics professors. When I went to college, I didn’t even know what an economist was, let alone that I wanted to be one. Within pretty short order, I was convinced that economists can do good in the world. We have tools to go at problems that are really important.

I’ve always been very motivated by public policy problems that economists can help with, and I was off and running. Some days, I’ve questioned whether economists really can and do good in the world. But I think that’s the orientation I’ve tried to take to an end and I’ve been very fortunate all across that way. With my education as an economist and the professional experience, I’ve had a chance to live that dream, to some extent.

[00:04:28] Alan

Very good. Obviously, you’ve been very involved in advising on policy and formulating policy. So I think we’ll get to that as we go through the conversation. You’re probably best known, rightly or wrongly, for the Sahm Rule, so probably a good starting point. Maybe you could just tell us what that is and what it’s saying at the moment about the current state of the economy.

[00:04:50] Claudia

The origin of the Sahm Rule ties very much into why I’m an economist. I worked on a proposal with several other economists on how to prepare us better for the next recession. So this was work done in 2019, before we even knew that a recession was coming, and the idea was to take policies that we often do (in my case, the stimulus checks) and put them on autopilot; tie them to economic conditions, have them be ready to go, and as soon as the economy takes a turn for the worse, get the help out. Congress figured it out ahead of time and get going.

So, to do these kinds of projects, you need to have an indicator, a rule that says okay, hit send, get the money out. This was a recession indicator. It was named after me later. It has not been used in that sense. No one has got money queued up and ready to go when Sahm Rule triggers. I am sorry to tell everyone. This idea of what are the conditions that we would see out in the economy that would very predictably tell us we are going into a recession is very important to know, early on, because things, once they start going south, can head south fast.

What are those early signs? The Sahm rule, the recession indicator, it uses the unemployment rate, it uses changes in the unemployment rate. So there’s no magic level. The United States has gone into recessions with unemployment rate of 4% and they’ve gone into it with unemployment rate at 8%. It’s really about how things deteriorate. Are they getting worse? Is the case, at least, looking over the past several decades?

It doesn’t take much of an increase in the unemployment rate to tell us we’re in a recession. Very specifically, the Sahm Rule says that you look at the monthly unemployment rate in the US, take the three-month average and the whole series. At that most recent value, if it’s a half a percentage point or more above its low over the prior 12 months, you’re in the early months of a recession. We’re not forecasting a recession, we are in a recession, in the first two to three months.

Now, half a percentage point doesn’t sound like a lot. And frankly, in the scheme of a recession, it isn’t a lot. In a typical recession, even the most mild recession in the US, you’ll see a two percentage point increase in the unemployment rate. More typically, it’s something like four percentage points. So again, we’re trying to get this early warning of where things are headed. Because if you are going to step in as a policymaker and make a difference, that opportunity is at the beginning.

That’s a real opportunity that can also pass you by before you even realize we have a problem. In the last few years, there has been a cottage industry discussion of, are we in a recession, is a recession coming, is a recession inevitable? And sadly, we’re back into the stage of it where the unemployment rate in the US has drifted up.

So earlier, when there were all these recession fears, the labor market in the US looked great. So the Sahm rule, it has not hit that half a percentage point level, and there’s nothing magical about it. Just because something worked in the past doesn’t mean… But we’re much, much, much closer to it than we’ve been at any point in this recovery.

[00:08:35] Alan

Yeah. So we would be just there or thereabout I’m thinking, is that right? I think there was a little bit 3.4. The most recent reading was more.

[00:08:46] Claudia

It’s about four tenths.

[00:08:48] Alan

Yeah. Four tenths. So we’re getting very close. So based on that, is it fair to say, Sahm Rule aside, if you’re looking at the broad set of macro data at the moment, would that concur with your assessment or would you be saying, well, maybe it might be better at this time? Do you think the risks are stacked in favor of a recession at the moment?

[00:09:12] Claudia

So in general, if I’m trying just as a macroeconomist advisor focused on what’s happening in the world, in the economy right now, I would always look at a wide range of information. I wouldn’t even just rely on my own rule. There’s no reason. When you’re doing policy, I had a reason why we needed a specific trigger to turn on. But we’re not in that. We can look at all kinds of information and sift through it. There are definitely concerns.

I see this more as risk. Things have moderated. We’ve gotten back into “better balance” as Fed Chair Powell likes to talk about balance. I think in the US, unlike some of our peer countries, we had a very rapid recovery. It’s not just that inflation came back. We had the jobs, the growth, the spending. The United States last year had above-trend growth. Things have been moving really fast, and we want to get onto a glide path. We want to come out of this in a sustainably good place.

When things are running too fast, it’s often not sustainable and you end up crashing. What we’ve seen in the past year of this moderation, for a lot of different reasons; in terms of workers coming back, in terms of some of the pent-up demand being worked out, in terms of just a lot of the irritants from COVID and from the war in Ukraine on the US economy working out. So we expected and we needed, in all likelihood, to see some moderation.

The tricky thing is, well, we’ve kind of had enough of that. We’re at a good, moderated place. This looks like where we could be in a growth path. But that means we’re much more susceptible. We don’t have the strength for policymakers’ mistakes to lean upon. You’re kind of at a spot where you’re more vulnerable than say a year or two ago when things were really strong in the labor market.

The labor market, for the US really, is the linchpin because most Americans spend what they make either because they have to or they like to, and most Americans, what they have to spend comes from their paychecks. So we’ve seen a very positive virtuous circle between the labor market and the American consumers. If you lose that, then you’re done. So just watching the US, the labor market, and how it’s doing is the big sign.

Of course, in a good $25 trillion-plus economy, hundreds of millions of people, it’s hard to get a read on even how is the labor market doing? We’ve gotten the indicators. What we know from the labor market recently, it’s been much more of a muddle, but that also tells you we’re not in a place like a year ago. There was no muddle. It was like those are really strong.

[00:12:40] Alan

On that, there’s a lot to digest. The most recent data was seemingly strong, but at the same time, the prior numbers were weak, and then you’ve had a recent pickup in jobless claims, and at the same time, the jobs have been easing. Putting it all together, how would you characterize it? Also, there has been some suggestion about questions about the validity of the establishment data, low response rates, etc. How much of a concern is that do you think?

[00:13:12] Claudia

It is imperative that one brings all the pieces of data together. The employment report that we recently received for May, if you said that I can only look at one series to make my judgment (which I feel like sometimes it’s how the outside world is going to pick one and go run with it) then your headlines would be wildly different.

The payroll employment number in May looked great, a far bigger increase month over month than what had been expected. It had been weaker a month before, but still, even setting that aside, is a really big number. So then people were like the labor market is strong and defying expectations. Okay, but then if you went into, let’s say, the unemployment rate. It hit 4% for the first time in over two years.

We’ve had a notable increase in our unemployment rate since the middle of last year. Even within that, the survey that gives you the unemployment rate, it also has an estimate of employment that’s very much not totally exactly, but it has some very clear ties to the jobs number in the survey, and that employment number was horrible. It was like a decline of 400,000.

If you picked any one piece, you could go off running and say very strong. So, then that’s a case where you put it together, and yet it is very frustrating and unsatisfying at a moment like this to be able to step back and say of the data, “Well, it’s just kind of a muddle.” Because honestly, that’s not good enough. If you’ve got this very positive, very negative, something in between, how do we interpret that?

There are measurement concerns. There are things that are popping up. This happens all the time with data. No data are perfect. There are issues. It’s complicated to be able to estimate any of these. The survey that goes into getting base payroll numbers, it’s like 100,000 firms for all the US that are representing. This is always the case. I’m not saying that this is something new to right now. But you can imagine that there are times and some of the very wonky I will not get into it, but some of the wonky issues that are popping up saying how we’re measuring the payroll jobs numbers, these kinds of issues show up in the “turning points”.

When the economy starts to change, if you’ve made assumptions about what’s the pace at which new businesses are being created and what’s the pace at which they’re leaving. So there’s the birth/death model. Because you have a survey, you don’t get to edit back in those new firms. You’re missing those new firms when you do the surveys, so you have to make assumptions. Well, those kinds of models are fine as long as things are moving along as they have been recently.

If you start to say, for instance, see the economy slow or things just soften up some, well, you’re probably going to be too optimistic about those new firms, those births, and thus could get the total jobs created too optimistic. And then when you get more information, be like, oh, okay, now we were starting to slow. So that information will come in later. I mean, this is the real irony or frustration of trying to look at the macro data.

It’s like when you most need that information to be accurate, when things are starting to change, is when it can put the most pressure on the statistics. Because the assumptions that are necessary to get the job done, are going to be most vulnerable when things are changing. And that’s why, to the recession indicator, you’re trying to find these subtle and yet reliable changes. Because it’s not going to jump out at you until it’s either far too late or it’s like five years later after you’ve done all the data revisions, and you go back like oh, yeah, I can see it now. And it’s like, yeah, but you didn’t see it then.

[00:18:18] Alan

Do you think the unemployment rate is the most reliable number for that? The Fed at times has looked at other measures like UCITS, etc. Is the unemployment rate just chosen because that’s what people focus on?

[00:18:31] Claudia

There’s an old adage among economists. Send me to a desert island. If I got to pick one macroeconomic statistic to take with me to say how the economy’s doing, it’d be the unemployment rate as a cyclical indicator. If your concern is, are we in a recession, going into a recession, the unemployment rate has a lot of signal relative to even say payrolls. So looking for negative declines in payroll employment is not going to get you moving early.

[00:19:14] Alan

A lot of people would often say, it might not be the case in this cycle, but often argue the labor market, the unemployment rate is a bit of a lagging indicator. Obviously, the standard leading indicators haven’t been very successful, things like the yield curve, etc. But do you think that in this cycle things are different and that it is something more to focus on in real time more so than some of those traditional leading indicators?

[00:19:41] Claudia

So this is where it can get interesting. What I’ve been talking about with the unemployment rate, this is an indicator of that we are in a recession. This is not forecasting a recession. The Sahm Rule is not the yield curve, thankfully. It is true that the labor market, in general, is lagging. It takes time. It’s like the snowball that turns into the avalanche. It’s already started to go that way before.

But just because the unemployment rate gets to its highest level (actually, after recessions end typically is when the unemployment rate hits it), that whole path from going into the recession to the worst of the recession, that does follow in a dynamic. So that’s where the Sahm Rule, this half a percentage point. There are other people that have tracked three tenths or four tenths.

Depending on whether you’re like, I want to be totally accurate, I’m in a recession, or I want to try and get ahead of recession. These small increases, these have been very reliably associated with recessions. This cycle has been so unusual in so many different ways that even what I think most of you will consider an even more tried and true recession indicator, we’re in a recession, it completely fell apart.

So in 2022, we had two quarters of consecutive declines in real GDP in the US. Many people refer to that as a technical recession. In some parts of the world, how a recession is defined is two quarters declines. And there is no recession in the US. That was when there was “Oh, a recession in the US, recession, blah, blah, blay.” And then I get to say, no, look at the labor market, the labor market is amazing. Consumers are spending.

There were things going on that seemed very COVID related in GDP. In all honesty, you have to go back to 1947 in the US to find two quarterly declines in GDP outside of a recession. And yet, for a lot of our conversations about COVID and the disruptions it caused, a parallel to World War Two is not a bad parallel. That could be the most comparable cycle that we have in our statistics.

So if these relationships, the small changes and small increases in the unemployment rate, being in a recession, if that relationship were going to break down; if the Sahm rule were going to break and that it triggers, we hit a half a percentage point, and then the employment rate just kind of stops rising, no recession. If it were going to break, it’s this time.

We’re in this tricky place of you don’t want to use the rules of thumb, use the rules of thumb, this time is different. Be careful, we’ve gotten burned. This time was like every other time that really gave some bad insights. But then as we get further and further away from some of the very unusual features of the cycle, well, then, some of those more usual rules of thumb, you might want to pay attention to them. We don’t quite know what to trust; what data to trust, what models to trust, what rules of thumb.

[00:23:53] Alan

On that, a lot of people were pointing to the rule of thumb around say a weakness in manufacturing tending to precede weakness in services, and that seems to have broken down. Another one, I guess, is the Fed tightens policy, and historically, something has broken. That hasn’t really been the case yet. We had SVB but we got through that. And then you hear arguments being put forward that actually, higher rates, given the structure of the economy and baby boomers, etc., higher rates might be stimulative, or at least a big cohort of the economy may be benefiting from the higher rates.

What’s an economist to do given all of those breakdowns in relationships and uncertainties and possible structural shifts in the economy? How do you say, well, we’re going look between all of that to see what are the things that we can still rely on?

[00:24:47] Claudia

Anything as complex as the past four years, you can pick any dimension, let’s say inflation because it’s gotten all the attention of late. Something that complicated, there’s really no one answer. So you’re going to have a whole host of stories in the mix, and then you’re down to running out the story, looking for the empirical evidence, and then just weighing it out.

It’s a real frustration in macro. In real time, we’re trying to give advice, as macroeconomists, based what we know about the world, what we think we know about the world. So you know there’s big question right now, is it appropriate for the Federal Reserve or other central banks to be cutting interest rates? Should they be waiting? What should they be looking for?

An important piece of that kind of forward-looking advice is what’s just happened over the past few years. How did that advice go that we gave over the prior few years? I was having a back-and-forth indirectly with someone who’s very big on that the Fed brought down inflation because of Fed credibility, inflation expectations. I’m quite adamant that this inflation cycle has had very little to do with the Fed, that this was COVID, and the disruptions it caused, and it’s taken its time to work itself through, and it’s taken time.

Yes, I think the Fed should have acted, but I don’t think the Fed should get credit for this. But honestly, at the end of the day, how do I prove that inflation expectations were not crucial? How do I prove or disprove that the American people believe the Fed? I don’t know. I work with the survey data. I don’t trust the survey data on inflation expectations. By the same token, how can I prove that these were very specific supply disruptions.

Some demand disruptions were due to COVID, and they had the unwinding, and it’s much more complicated. It’s not just this idle who gets credit for what. These are really important now for what does the central bank do. If they are convinced, if the Fed is convinced that it’s because of their tough talk on inflation that they got inflation under control, well, then they’re going keep doing the tough talk because we’re not quite there yet. Them and their tough talk got it down. But it’s like the labor market is not as great.

In the end, there will probably be, if someone could actually go in and adjudicate what was it, those two things; the roles of central banks managing the expectations of biting inflation, COVID dissipating, these will all be in the mix. I’m sure of that. It’s just this argument about exactly how much, we won’t know. It’s important for policy right now and it’s really important for policy.

Going forward, the only thing with these inflation expectations that will keep it going is a framing that comes out of this group of really smart economists thinking in this space, is that, well actually, this time really wasn’t that different. Because this whole inflation expectation, central bank credibility, this is how we dealt with inflation in the past. So really, there was nothing new to see here, folks.

That’s the piece of it that I was just like I feel like COVID should be a wake-up call to all of us that there are types of inflation that our central banks are not well suited to fight and probably shouldn’t be because they’re much more targeted. If we walk away saying, oh, no, it’s all the central bank, then we’ve missed the opportunity to step up and be like, we’re missing some tools here. Because we should not be relying on the passage of time to heal inflation. It is painful for a lot of people.

[00:29:25] Alan

Are you saying it was all supply-driven? Team transitory were ultimately right even though it took a little bit longer, and the Fed was a sideshow. Is that fair to say?

[00:29:41] Claudia

That was an explanation that would have been missing in any normal kind of inflation cycle, and I think it was absolutely core to this inflation cycle.

[00:29:50] Alan

What was unusual with this cycle, you could say that the Fed can claim credit for bringing in inflation, but it was unusual that they were able to raise rates by over 5% and it didn’t materially impact the economy, which was very unusual themselves.

[00:30:05] Claudia

Normally, when there is an inflation cycle, fighting the inflation is all about the Fed. It’s considered to be its center stage. They’re the ones that go after the inflation. This inflation cycle has had very little to do with the Fed. They’re there and they did have a role. We did have demand pick up in a way that was almost unsustained. Some of that burst of demand came from the extra relief money that went out during the first year of COVID.

A big demand shock in the US, at least the US in general, was when we shut the economy down. People were afraid to go out and be doing service, like being out in public. so you had a lot of pent-up demand that when the vaccines came out in early 2021, just flooded in. The Fed has tools and should be using tools when there is a flood of demand because they have interest rates, they can raise them, interest rates are a price. Interest rates can help bring that demand down. So the Fed should be there.

In a lot of ways, we should be really thankful this inflation was not the garden variety inflation, because if it were, we would have had a huge problem. Because, as you pointed out, the Fed’s “transmission” was pretty weak. To me, this is another fascinating thing about what we will likely learn from monetary policy over this period. We often talk about, oh, well, we got up to a certain level of interest rate.

The federal funds rate is a little over 5% in the US right now and has been for some time. Okay, so yes, that is notable. That’s much higher than it had been. What was just mind blowing, in 2022, is we went from essentially zero to 500 in like a year. Not only was it fast, it was unexpected. Even when they started raising interest rates at the beginning of 2022, nobody had four 75 basis point hikes, things just really took off. So you went from an environment of essentially really low interest rates to, for many several years, high interest rates.

What became problematic for the Fed, in this regard, in it’s tools is, so the Fed because it moves interest rates around, moves its Fed funds rates, financial markets, moves interest rates around. Their effect on demand is going to come through demand-sensitive sectors. The housing market should be a great example of where the Fed can do its work in the United States because mortgages tend to be 30-year fixed. They have fairly long duration relative to a lot of peer countries.

On top of that, what happen when interest rates are so very low, right after COVID, you had a big boom in home purchases. So you had people out buying before they raised rates, so like late ’20, 2021. And then on top of that, and the big one is the vast majority of people who had 30-year mortgages, they refinanced their mortgages when mortgage rates were at rock bottom.

The typical US homeowner, their monthly mortgage payments are lower now than before COVID. The Fed can raise interest rates all they want. Most people don’t move. Most people aren’t buying. But this was a case where if you hadn’t had that going from zero and all that refinancing, there were some real extremes there. But then that’s meant, so then you get into that the Fed starts raising interest rates, they want to cool off demand. Well, typically when the Fed, and you see this actually in other countries that have shorter-term mortgage debts that house prices have fallen.

But in the US, the house prices have actually risen because of this structure where people had- they now are sitting with mortgage rates that are so much lower than the market mortgage rates and so they don’t want to sell, they don’t want to move because they’re going to end up with all these extra costs. So then they don’t put their homes on the market.

So, yeah, there’s less demand because interest rates are high, but there’s even less supply, and so that pushes up house prices. So, you can see where this one of the spaces where the Fed should have its entry point in. Housing is interest rate sensitive, but it has not gone according to plan.

[00:35:34] Alan

Based on all of that, the Fed is still progressing forward with I suppose its standard approach in terms of it seems to be trying to assess whether policy is tight or not, still talking about things like R star, and to make that assessment is kind of looking at what does the current indicators say about the level of demand in the economy. Do you think that is right? How much weight should the Fed be putting on its inflation mandate versus its employment mandate? How do you see policy evolving from here?

[00:36:18] Claudia

The Fed has a dual mandate. I think the Fed has done, if they agree with this. The discussion coming out of the Fed has absolutely shifted as inflation has come down and the unemployment rate has risen. They have recognized that the risks of inflation coming in higher than they expected, and the risk of unemployment coming in higher than they expected, these are getting much more in balance there. There’s still risks. They’re writing down what they think is the right forecast.

But those are words. Those are not actions. And yet, that’s a good first step. And clearly recognizing that wasn’t the rhetoric in 2022 or early ’23 when inflation was really high, and unemployment was very low. So yeah, there is an evolution in the way they’re talking about or setting out their thinking that is consistent with an appreciation of the dual mandate. It’s still the Fed. And any of those central banks, whether they have the tools that are necessary to deal or have been necessary to deal with this inflation, they are the institution that’s tasked with inflation.

There are other institutions that could step in, but the central banks have it in their mandate, and often they are singular in that sense. There’s not another government agency that also has that in their mandate. So it is understandable that there’s a heightened concern with the inflation. I feel like the ECB might be a model for having shaken this off, which I would never have expected.

Early in the year, you can still see this in the Fed’s rhetoric, Raphael Bostic, so the president of Atlanta Fed, in a good example of this was talking about how the worst possible outcome this year would be for the Federal Reserve to cut rates too soon and then to have to raise them again. To me, that’s just one where it shows this inflation bias. I think, arguably, one could make a good case that the worst possible outcome this year would be an unnecessary recession to get unnecessary.

Inflation was coming down anyway and the Fed allowed or caused a recession. But that goes to this strong man view of central banking, that we can’t be seen as looking soft on inflation. Policy adjustments happen all the time. This is kind of talking about or talking up to the markets. “Oh, when the Fed cuts, it’ll be seismic and all this unwinding.” And it’s just like, I just watched Christine Lagarde last week give a press conference where the ECB cut despite the fact that they’ve gotten some data that wasn’t as encouraging, making very clear we might not cut again. The world kept spinning, and I didn’t feel like the ECB was thrown to the side.

Now, it could end up being a “mistake,” and that they do have to raise. But again, if the ECB raises, does the world stop spinning? The margin of error in Europe is not as high. The US, because it had such a strong recovery in the last few years, are in a place where… We’re on a better footing than a lot of Europe in terms of the economy. And yet, the Fed shouldn’t be running that out and kind of abusing.

[00:40:44] Alan

I want to talk about fiscal policy. That’s been one of the parts of the story that has,, I guess surprised people. Going back 12, 18 months ago, people were calling for a recession, and then we’ve had significant fiscal support in the US and deficits of 6%, 7% of GDP. We’ve had this active industrial policy as well. We had the fiscal support during COVID and now this industrial policy.

We had Gary Gerstle on this podcast recently. He’s the author of “The Rise and Fall of the Neoliberal Order.” So he’s kind of arguing that we’re past the neoliberal age. What preceded that was the New Deal, obviously, and I know it’s something you’re interested in. But I suppose the question is, are we heading back to more of a New Deal type of economics and more active fiscal policy and generally more higher deficits over time as well?

[00:41:44] Claudia

Regardless of who wins in November, there’s no reason to expect smaller deficits in the US. There are several aspects of the three big investment programs. So the infrastructure, the CHIPS Act, the Inflation Reduction Act, they clearly mainly, move production in the US, build up productive capacities. Many, not all, but most of those programs were with bipartisan support. So there is an aspect of that. That theme is there in general.

The industrial support, the more like focused on friendshoring, nearshoring a particular trade disengagement is even too nice of a word, but like a trade relationships say relative to China being much less favorable. So exactly the degree to which any of these things play out, and the degree will matter in terms of, well, do we think it adds a 10th to inflation or do we think it adds a percentage point to inflation? So we’ve got proposals that are all over the place. So, I think on the industrial side, industrial policy, it’s there, these programs are incredibly hard to do.

But one thing that will be interesting with some of these policies, and not just industrial policies, but also some of the more New Deal social policies, do people want them? Are they popular? This was a frustration, I think having worked in a lot of President Biden’s early on programs like with the American rescue plan, this big fiscal relief. This was still one big push out of COVID. But it had some of the social part, like the child tax credit.

So extending the child tax credit, which was essentially a give the same amount of money to kids regardless of where their parents work, how much income they have, much more like a child benefit than other countries would have. The first time in the US didn’t depend on work. And cut child poverty in the United States by like half, which is says a lot about how sad our safety net was for poor children before it.

Did people fight for it? No. It didn’t poll particularly well. It did fall victim. It’s extension fell victim to inflation took off and there were a lot of other concerns, but even setting that aside, it didn’t particularly resonate with people. These are big, expensive programs. These are major changes in how we either support American families or how we support American businesses, different communities. You’re starting to pick winners and losers. It was fiscal. It’s a political economy.

There is a constituency to always line up behind corporate tax breaks. They will probably be out there. I think that’s one,that aspect of maybe the economists, I have nothing to add on how it resonates with people. Some of the way these programs landed was not as I would have expected.

[00:45:32] Alan

Interesting. But as you say, it seems like no matter who is in the White House next year, the bias is for more spending and little appetite for austerity. So from the perspective of debt sustainability and whether there are concerns around that, people always look at bond yields, but the other side of it is growth as well.

What’s your sense, thinking about the economic growth picture on a multi-year perspective and the factors that might influence it like immigration and labor force participation and productivity and things like that? Are you more or less upbeat on the medium to longer term outlook than you might have been going back a few years or not? How do you see that?

[00:46:29] Claudia

A clear lesson from this recovery, at least the United States relative to say now versus not just after the Great Recession, but after 2001 and 1990, having a strong and rapid recovery, particularly in the labor market, does so much good, and as a corollary, avoid so much bad. We’ve had these bringing people in from the side. We’ve had this amazingly labor growth.

One thing we’ve seen in the US is productivity has moved. Talk about something that’s tough to measure and can show up and disappear and come back. But that’s huge, and then there’s a real story. We are also investing in infrastructure. Business investment has looked great, not just what the government is doing. We are creating productive capacity in a way that has not been the case in earlier, slow grinding recovery.

So it’s like we had a good base it and it reinforces how important it is to keep above a stall speed, to keep things going, that there’s enough dynamism that you’re bringing in more, and then it can add to it. There was so much less scarring from the COVID recession. I mean, really, anybody should have thought when it happened. That was massive.

There were so many ways this was different, and yet there was a very concerted policy response across the entire world in the economy. Let’s get out of this as quickly as possible. Maybe things were done too much, not the right thing, inefficient, at different times. But there was a clear let’s get out of this. By and large, that has paid off.

Now, using that principle of let’s put the money in, let’s invest in the economy so that we can help support that growth, that is the path that we’re on. I think it’s one that can pay off well. I think in the US, the conversations around the sustainability will become more challenging. Again, these are all big activist programs. This is how they spend money.

They’re very like the government in there being active, markets have to believe or feel that they’re getting proof that the money is being “well spent”, that the outcomes are going to be good. As I said before, nobody has on their platform a meaningful plan to get the budget deficit down. Maybe they don’t need to. In the foreseeable future, we still have enough buyers for the government debt.

But the thing is with the US, because of where the problems are, where the big spenders are in the entitlement programs so what we have or pensioners whether it’s the retirement benefits, the medical benefits, the taxes which there are limits. Some Republicans have put limits on increasing taxes. These are things where like nobody wants to touch these. The levers you have to pull to bring down the deficit are just politically complete nonstarters. So then the only way the United States addresses its deficit is in crisis.

[00:50:34] Alan

The other way people sometimes say is obviously through higher inflation, and that’s actually obviously been helpful in the last few years as well. Do you think that is ever an actual conversation at the Fed or elsewhere to say, hey, let’s let inflation go a little bit higher because it allows debt sustainability?

[00:50:54] Claudia

No. I think this cycle reminded us how much people hate inflation. You could have something like, oh, no Fed, your target is 3%. Congress could say that. But then Congress would have to answer to the people being like, what do you mean I’m going to pay more for my eggs so that some badly run government program can… Yeah, I don’t think that’s going to be the solution piece.

The problem is that, in the US, there’s a lot of discussions. You’ll hear a lot about, oh, I have a proposal, I have a solution. That actually doesn’t solve anything. So in the US, despite some of the policy discussion… You have some on the right that will more or less come across you, let’s cut all discretionary spending, outside of military, to zero. Everything from corporate, every social program.

The thing is you could do that. You shouldn’t. Even if you did, you would still have a huge debt problem. These are just not big enough. By the same token, you cannot go in and do all of this by raising taxes on the 1%. There is a tax shortfall that could be addressed. At the end of the day, something has to happen where you go into entitlement spending, and either cut benefits or raise taxes on entitlements. But, a crisis, is very good at sharpening the mind.

So the economic solutions here are pretty straightforward. They’ve been with us for decades and decades, it’s just a matter of a moment that is dire enough. We’re not there and it’ll be far worse than the whole balancing the… It’s really unfortunate that that’s where that will go. But it may just be that it takes a very long time when we figure out some other things.

It’s not my base case that we have debt sustainability come home to roost in the next four years, but it’s gotten a lot more attention. I think probably the more we talk big fiscal programs, it’s going to keep getting attention.

[00:53:19] Alan

Good stuff.

I’m conscious we’re coming up to the hour and we always ask our guests things that were influential, maybe books or read over the course of their career or any suggestions or advice they have for people who are interested in economics as to interesting sources of information. Any suggestions or anything that was very influential for you or anything that you would point to for people who want to get better at economics and macroeconomics?

[00:53:50] Claudia

My thinking about economics can often be shaped most by the time I spend not thinking about economics. Learning economics isn’t all about just picking up every textbook, listening to the latest economist, thinking of this, that or the other. The economy works like it’s just one piece of a bigger puzzle. As someone who works with fiscal policy and actually come to this policy, I find the political economy very interesting. This is not standard mainstream.

I didn’t learn about political economy in my PhD at Michigan. At Michigan, I did some at Denison’s undergrad. So I think the political economy can be very interesting. That’s a whole wide range that you can read up on. I am absolutely fascinated by the history of economic thought, just how people like me answer these kinds of questions. What would I have said now versus the me equivalent of 100 years ago, or 150?

It does give you a lot of humility in whatever we think is the best explanation or the best tools we have for addressing a problem today, you’re going to have to go sometimes even five years later for people to look back and be like, oh, yeah, that was really simple thinking, or how could they have used that method? But that’s how we make progress, right?

So it isn’t good not getting too attached to your own thinking about stuff, because like, no, actually, I want to be proven wrong because I want to figure out the right answer. So kind of that humility that it’s not just all like we know right now, it’ll change. But again, you have to get outside of the discipline to see that, because it’s hard if you’re just reading economists to get that sense.

[00:56:00] Alan

Very good. Some good suggestions.

So, Claudia, thanks very much for doing this today. It’s been a great conversation. Make sure to follow Claudia’s work because as you can tell from today’s conversation, we are living in a truly global macro driven world and it’s more important than ever to stay informed.

From all of us here at Top Traders Unplugged, thanks for tuning in. We’ll be back soon with more exciting episodes, so stay tuned.

[00:56:25] Ending

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