A BIG 2023 Economic Forecast from Harvard’s Jason Furman

Dave:
This is On the Market, a BiggerPockets podcast presented by Fundrise.
Hey, what’s up everyone? Welcome to On the Market. I’m your host Dave Meyer. And today we have a super cool show for you today. We have one of the most preeminent economists in the entire country joining us. His name is Jason Furman. He’s an economist and professor at Harvard University. He’s also worked in the government. We have a fascinating conversation about really just the broad understanding of what is going on in the economy and how we arrived at the point we are today.
Jason has some really sophisticated, I think, well-informed and often critical views of some of the stimulus packages, some of the Fed policy that we’ve seen over the last couple of years. And he has a pretty different prescription for what the Fed should be doing going forward than I think a lot of the people that we have talked to on this show over the last couple of months or just basically what you hear in the media. So this is a fascinating episode. We talk about stimulus, we talk about inflation, we talk about the debt ceiling negotiations that are going on in Congress right now. So if you want to understand the economy as it stands today, at the end of May, you’re going to want to listen to this episode with Jason Furman. We’re going to take a quick break to hear from our sponsors, but then we’ll be right back with the interview.
Jason Furman, welcome to On the Market. Thanks so much for being here.

Jason:
Great to be here.

Dave:
Can we start by having you tell us a little bit about yourself and your background as an economist?

Jason:
Sure. Just to go way back to the beginning in my origin story, I loved math and physics. I loved the real world and I thought economics was a great way to combine the two of those. I thought I was going to be a pure academic, went straight from college to grad school and then got recruited to work in the middle of grad school at the Council of Economic Advisors in the White House, and that introduced me to the policy track that I’ve been on ever since. Ended up being in the Obama administration for eight years, including as Chair of the Council’s Economic Advisers. For the last six, I’ve been back at Harvard teaching, researching, writing, and occasionally appearing on podcasts.

Dave:
Great. Well, we’re happy that one of those occasions is for this one. We appreciate you being here. So can you give us an overview? There’s so much to talk about with the economy, but how would you categorize the current economic climate right now?

Jason:
Largely, it’s been one of a lot of demand. And demand brings some wonderful things, low unemployment rates, especially for some of the most vulnerable. And demand brings some bad things in terms of inflation, which has been very stubborn and persistent.

Dave:
Why do you think that inflation has been so persistent?

Jason:
Look, I think when people first missed the inflation, and I think there’s just no limit to how much one should obsess over those errors that were made in forecasting in 2021, errors I mean by everyone, the Fed, financial markets, the IMF, forecasters, everyone.
I think what happened was every time people missed in their forecast, they thought there was some unfortunate event that had caused it. The vaccines are working too well. Then omicron came. “Well, we have inflation because the vaccines aren’t working well enough. We have a problem in our ports. We have a problem with our chips. We have a problem with Russia invading Ukraine.” And it just was one unfortunate event after the next. I think there’s a more parsimonious explanation, which is that rather than it being caused by the series of shocks, a series of things on the supply side, that it largely emanated from the demand side. We spent 25% of GDP. We kept monetary policy extraordinarily low. So that’s where it came from.
Now what’s perpetuating it is partly the demand is still there even with all this monetary tightening. Fiscal policy has long and variable lags and it’s still boosting the economy, but the bigger thing is inflation just takes on its own self-perpetuating dynamic where wages cause prices, prices cause wages, and all of it sustains itself and that is, I think, I call it wage price persistence. I think that’s where we are right now.

Dave:
Can you explain to our audience a little bit more about the wage price persistence and how we are in a cycle and how you traditionally get out of that?

Jason:
Yeah. So some people use the word wage price spiral. Most of the people use the word wage price spiral, use it as a straw man in order to tear it down and they’re like, “Oh, wage price spiral is one day prices go up four, so then wages go up six, so prices go up 10, so wages go up 20,” and soon you’re in hyperinflation. That’s not what I think is happening. No one thinks that’s what’s happening. So if you’re putting your energy into arguing against that, you’re arguing with a straw man. What I think is happening is prices and wages are set in a staggered way. If you’re a business, you have some input costs, some labor costs, you set your price in February. Then some other business sets theirs in April. Then some worker does their negotiation in June. And that happens in a staggered way throughout the year. And an input into that process is whatever happened to wages and prices in other places that you’re drawing on as an input.
And that’s why right now, one way of looking at inflation is looking at wage measures. They’re generally running at about 5% a year that you can afford 1% of that with productivity growth, so you only need 4% price increases when you have that type of wage increase. Another thing is to look directly at prices and underlying measures of inflation are also running at about 4% a year. So both the wage and the price right now are rising at a rate that’s consistent with each other.
Now, how does it end? The happy way for it to end would be if inflation expectations are anchored and they serve as sort of a gravitational attraction. And so you’re a business and you say, “Yeah, my inputs went up 4%, but inflation’s coming down so I’m going to only raise my prices by 3.” And then the next business, “Oh, my inputs went up by 3, but inflation’s going away. I’m going to only raise my prices by 2.” And then it becomes self-fulfilling. That’s the hopeful happy way that inflation painlessly goes away. Unfortunately, the more common historical way that inflation goes away is with a recession and higher unemployment. And my guess is we’re not going to see inflation below 3% unless we have a recession.

Dave:
So in the happy medium, it’s basically just a psychology, or a happy outcome. You’re saying it’s basically an inflation expectation problem where you are counting on people seeing the trends of inflation and then making business decisions accordingly. They’re not necessarily being forced into lowering prices or slowing their price increases based on a lack of demand.

Jason:
Yes, that’s the happy story. And look, you see some of that. If you look at business surveys about what they expect inflation to be, their expectations for inflation have come down a lot for the near term. And in the long term they’re basically 2%, exactly what the Fed is targeting. If you look at surveys of plan pay increases, those have also come down a lot too. And so the hope is that the last two years were just some crazy unusual period of time. And everyone knows they were just a one-time event and now we’re back in a normal world. And in a normal world, you raise your prices by 2% a year or depending on your business plus or minus, and that businesses recognize we’re back in a normal world and they’re back to behaving normally. As I said, that’s the happy story. There’s a chance it’s true, but it’s not where I would put the majority of my probability in assessing what likely could happen.

Dave:
Okay. Well, I do want to get to that. I want to understand what you think is likely going to happen. But before we move on to that, I want to get a better understanding of your thoughts on how we arrived here. You said that you don’t believe this supply side shock narrative and that it’s mostly demand. Can you tell us us a little bit more about what drove that demand? Was it all monetary policy? Were there other things at play?

Jason:
Look, first it was fiscal policy. It was about $5 trillion which measured relative to a single year’s GDP, it’s about 25% of GDP. In 2020, that was totally understandable. The world was collapsing. We had no idea what was going to happen, how long it would last. Huge fog of war situation, don’t have any blame for policymakers.
By 2021, a lot of the fog had lifted. It was pretty clear that the main thing needed to drive an economic recovery was just to reopen, to vaccinate people and reopen, and that a lot of the fiscal support was redundant. But then the error I think was in some ways a less forgivable error, but maybe not more consequential because then monetary policy continued to stay on its easy course. Fed did not stop buying assets and did not start raising rates until the unemployment rate was basically 3.5% and the inflation rate was over 5%. I think monetary policy makers were to some degree fighting the last war and had a very asymmetric approach where they were much more worried about employment than inflation. They were willing to use forecasts asymmetrically to say, “The inflation’s going to go away. We don’t need to raise rates.” And so I think that helped perpetuate the inflation.

Dave:
Interesting. So yeah, in your perfect world, there was a stimulus in 2020 you’re saying with the fiscal policy. Do you think the second and third were unnecessary at that point?

Jason:
I think the second was perfectly reasonable. And I think the third was mostly unneeded beyond the hundreds of billions of dollars related to COVID itself, the vaccinations, the testing, et cetera. I think that continued to be very important through 2021. But certainly the third round of checks, it was completely unnecessary. The magnitude of the unemployment insurance and an economy with a huge number of job openings I think was also unnecessary. Now look, these things are difficult when you’re in the moment. It’s hard to know exactly where things are going. There were people talking about the economy slipping back into recession in 2021, absent all of this support, but I don’t think that view was right. Certainly in retrospect I don’t think it was a reasonable thing to even think at the time.

Dave:
And you mentioned that a lot of the stimulus and sort of lags, its impact on the economy lags over time. Is there any precedent that could help us understand for how long we will feel the impact of that stimulus?

Jason:
No, there’s no precedent at all.

Dave:
Okay, so we’re just guessing.

Jason:
Yeah, we’re just guessing. We’re absolutely just guessing. And the reason is, first of all, the scale of the assistance. If you give someone $10, they might spend it right away. If you give a household $10,000, and by the way, we gave a lot of households 10,000 or more, they’re probably not going to spend it right away and we just don’t have experiments with that. The other thing is we gave households money at a time when initially they couldn’t spend it, at least spend it on services. They could spend it on good. So I think this experience is just so unique.
And that’s one thing I would say, is anyone who says, “I have the one true model and I’m going to solve my model and tell you exactly what’s going to happen,” I don’t believe you. If you tell me, “I’ve thought through four different models and I’ve talked to four people that have businesses and I talked to four of my uncles. Based on those 12 things, here’s the risks and here’s the upside, downside and here’s the range of outcomes and here’s how I’m going to manage that risk,” I think that approach is much better.

Dave:
What do you see as being the best policy forward from where we are today?

Jason:
The big question now, and this is a conventional wisdom that’s out there, I’m just stating what everyone else is stating, is that we don’t know… First of all, let me just say we need less demand. We need to bring inflation down. The only way to bring inflation down is with less demand. Most of the monetary policy tightening that we’ve done has already worked its way through the system. Financial condition tightening, which is how monetary policy worked, largely happened nine months ago. So I don’t think there’s a lot of lags in monetary policy that will save us. Where there may be something that will bring about the demand reduction sufficient to bring inflation closer to target is the credit contraction from the turmoil and the banking system. So I am okay with the Fed pausing at the next meeting waiting to assess how much the turmoil and the banking system is doing their work for them and getting inflation down.
My own guess is that that credit contraction is not large enough to accomplish what I think is a quite big overshoot, continued overshoot on inflation on their part. And so I think after their June pause, the macro data’s going to be telling them that they need to go again in July or September. So I think we’re going to need another hike or two this year, but it’s fine to wait for more data to make that decision. I think there should be, and I think there is, a very high bar to cutting rates. And it’s hard for me to see anything short of a financial crisis breaking out, and I don’t expect that, that would lead the Fed to cut rates before November at the soonest. And even then, I think it’s unlikely.

Dave:
What are the main indicators you look at or the Fed is looking at that would support this idea that they’re going to need to keep raising rates?

Jason:
First of all, I like to look at a lot of different inertial measures of inflation. There’s the standard ones like core where you take out the food and energy. There’s the median and trim mean, which take out the outliers on either side. Housing has played such a big part in all of this, so I like to look at ones that swap in new rents for all rents in the housing component. I’m not as much of a fan, but the Fed is, so I look at it core inflation excluding. Housing and used cars. Core services I mean, excluding houses and used cars. So I look at all of those.
Now the interesting thing is every one of those right now is telling a very similar story of inflation in the 4 to 4.5% range. Sometimes the data is confusing about what’s going on. Right now it’s actually not. It’s all lined up. I think the wage data I think is really important. Unfortunately, average hourly earnings which come out every month are sort of junk, just they’re measured badly. So if I knew and believe them, I’d love them, but I don’t believe them. The ECI comes out every three months. I believe that. I love that. But you have to wait so long to get it, so you’re really painful trade-off on the wage side between the timeliness you’d like and the accuracy.

Dave:
What is the ECI? Sorry to interrupt you, Jason, but what is the ECI?

Jason:
Oh, sorry. Sorry. Sorry, sorry. The employment cost index.

Dave:
Okay.

Jason:
It’s just a measure of wage growth or compensation growth. And what’s good about it is they measure it in a way that isn’t distorted by changes in composition of the workforce. I think openings and quits are the most important labor market indicator, much more important than the number of jobs or the unemployment rate, which of course gets the most attention. But if you give me another 40 minutes, I will list you 40 more minutes worth of indicators that I look at.

Dave:
That’s a great list and probably more than sufficient for our audience. I’m curious though to dig in a little bit more about the labor market. It does seem to be holding up very well by most metrics that I’ve seen at least. I’m curious how you think this is going to play out and if there is risk of a serious job loss recession coming in the next year or 18 months.

Jason:
Anything could happen of course. I think it would be wonderful if inflation comes down without the unemployment rate going up. There are ways that could happen. We talked a little bit about inflation expectations might act as a gravitational poll that businesses go back to normal price increases and wage increases. We are seeing declining job openings without the unemployment rate rising, so the labor market might be cooling a little bit. So it’s really high employment rate, but a high employment rate in a cooler type of manner.
Unfortunately, I think the more likely thing is that a higher unemployment rate is the only way to bring inflation down. And the longer we delay that, the more unemployment you’re going to need, the more embedded inflation gets. You’re risking millions of additional job losses to get rid of a more deeply embedded inflation. And so I think probably if you tell me at the end of this year, the unemployment rate’s still 3.5, my guess will be inflation is still pretty high and so the Fed’s going to raise rates a lot more next year. They’re just going to keep repeating until there’s both a recession and a way to bring inflation down.
Now, could you come out of the recession and come back to lower unemployment? Yeah, maybe you could, but I don’t think the Fed needs to set the goal of raising the unemployment rate, but it needs to be willing to risk that happening in order to achieve the goals it’s set, and goals that have served us well historically.

Dave:
Do you believe that raising interest rates is an effective tool for raising unemployment? Because so far it doesn’t seem like there has been a relationship between raising the federal funds rate and the unemployment rate.

Jason:
Well, we don’t know what the counterfactual would’ve been. If the Fed had not been raising rates for the last over a year now, where would the unemployment rate be now? Where would inflation be now? I think the unemployed rate would probably be lower and the inflation rate would be higher. I’ve done reasonable quantifications that suggest maybe the unemployed rate would be 2.75 right now, and the inflation rate might even be 2, 3 percentage points higher than it is.

Dave:
Wow.

Jason:
So it’s possible the Fed prevented something. And this is where that lag fiscal policy becomes quite important, which is, it’s not like you gave people money in 2021 and it all got spent in 2021. A bunch of it got saved and spent in 2022. Some of it got saved and it’s being spent in 2023. And so part of what happened last year, I think, is that that monetary policy fought fiscal policy to a draw. And you see that in the data. Consumer spending is mostly affected by fiscal policy. That’s been quite strong. Housing is mostly affected by monetary policy. That’s been quite weak. The reason we didn’t have a recession is because consumer spending was unusually strong even as the housing sector was getting on cream.
So yes, I do think monetary policy has been working, is working, and will continue to work. I don’t like the fact that monetary policy operates on a limited set of sectors. I wish it’d spread the pain across the whole economy instead of concentrating itself on some sectors like real estate. But we sort of go to war with the tools you have, and that’s the tool we have. I think there is an interesting question and debate as to whether monetary policy has become less effective over time, that it used to work really well when we had a lot of manufacturing in our economy and people bought a lot of cars. And now that manufacturing is smaller and car purchases are smaller, the economy is less sensitive to interest rates than it used to be. I think that’s possible. I think interest rates just may not matter as much as they used to matter. But they matter and you see it in the housing sector. So yeah, I think it’s probably working compared to some counterfactual. Of course, you can never prove that.

Dave:
Obviously for our podcast, the housing sector is of particular importance. I’m wondering if you have an opinion on the direction of mortgage rates throughout the tightening cycle and if you think we’ve hit a peak back when they were about 7 and change in November, or you think there’s a chance that bond yields go up in the coming months and bring mortgage rates up with them?

Jason:
I think there is more of a chance that we’re going to see mortgage rates go up than go down. But when I say that I am talking about 25, 50 basis points, not anything like the experience that we went through in the first half of 2022. I certainly think no investor business should be making a plan, assuming that mortgage rates are going to be a lot lower one, two, three years from now. Maybe they will, in which case, great, you got lucky, enjoy it. But if your plan only works if mortgage rates fall, I think it’s a bad plan. So why do I think this? It’s that I look at the Fed fund’s future rates, and for the next FOMC meeting, they think the Fed is going to pause. I completely agree. For the meeting after that, they think they’re probably going to continue the pause, but maybe will do something else. And then starting in September, they get very asymmetric about the Fed is going to cut rates rather than raise rates.
My own view is the exact opposite, that if the Fed moves again at the next three meetings, maybe even the next four meetings, it’s going to move to raise rates, not to lower rates. And so I think there’s a little bit of over optimism about how easy it is to bring down inflation, about how much of the job has already been done and too much complacency that the Fed is completely done with its tightening cycle. So I think there’s a little bit of unpleasant surprise left from the Fed. That gives me a little bit more of a mortgage rate’s likely to drift a bit up, not down. But again, the huge moves are behind us for sure.

Dave:
The one thing I’ve seen that suggests that rates could go up considerably is Zillow published something saying that if the US defaulted on its debt, that mortgage rates they were forecasting would go up and stay above 8%. I’m curious what your read on the debt ceiling negotiations is at this point.

Jason:
Yes, and I should be clear, everything I just said a moment ago was assuming that the debt limit gets raised. So this is sort of the normal economic forecasting, not the “What happens if there’s a catastrophe?” I actually think they are on track to settle the debt limit. I know firsthand, and it’s been in the press, that the conversations between the administration and the Congress have gone quite well, that all the parties see a landing zone. The president calls it a budget negotiation. The speaker calls it a debt limit negotiation, whatever. They can each call it whenever they want. It’s still the same law and signed by the same person. So I have a decent amount of optimism.
And just to be clear, by the way, that doesn’t mean it won’t fall apart in acrimony and come together again three times between now and June 1st. I think there’ll be drama, there’ll be unnecessary brinkmanship. It will take too long and ultimately it will get solved. But that’s not definitely the case. It is definitely a real risk to the economy. Is it a 3 to 5% risk? I think it’s in that neighborhood. Not more than that. But 3 to 5%. If my doctor told me, “You only have a 3 to 5% chance of dying by June,” I wouldn’t be too thrilled by that prognosis. And if we go past the X date, if we default, interest rates will go up, stock market will go down and lots of other bad things will happen.

Dave:
Yeah, I mean I guess we don’t know exactly what would happen, but yeah, I’ve heard interest rates would go up, stock market would go down. Are there any other high level consequences of potential default that you think our audience should know about?

Jason:
Right. Needless to say, it’s not like we have a larger data set to draw on. When other countries have defaulted, it’s because no one wanted to lend the money. The United States would be unique in becoming one of the first countries’ effort to default because it refused to borrow the money that everyone was perfectly happy to lend it. And so yeah, we don’t know what that looks like, but we do know a little bit. From 2011, we started to see interest rates go up. 2011, the stock market went down 20%. Consumer confidence plunged. And that was all just because we got close to the date, not because we went over the date.
Now the other question is, what happens if treasuries get downgraded? If treasuries already been [inaudible 00:27:02], if the other two agencies downgrade the treasuries, how many institutions out there are required to hold… AAA securities can no longer hold treasuries need to dump them. What happens if treasuries no longer function as collateral for loans throughout the financial system? What happens if they’re no longer being held by money markets? There’s a lot of different places in the financial system that you could see a run on the financial system, a dysfunction in a world where the one safe liquid asset no longer is that.

Dave:
Obviously those are all pretty significant… Well, you mentioned some significant domestic issues, but I assume that when you’re talking about the financial system, you’re talking about the international financial system and that this could spread to sort of a global economic crisis?

Jason:
Absolutely. I mean, I don’t think Russia and North Korea would have much to worry about. They don’t have a lot of treasuries in their financial systems. But every other country in the world, US Treasuries are a very important part of what underlies their financial system.

Dave:
Well, I’m heartened a little bit. I agree with your doctor’s assessment that I wouldn’t be thrilled with a 3 to 5%, but I’m glad to hear that your risk assessment of a default is not worse than it is. Jason, this has been super helpful. Is there anything else you think that our audience, primarily of real estate investors who are trying to attain financial freedom through real estate investing, should know about the economy right now and how they should make financial decisions?

Jason:
Yeah, I’ve told you what I think, but I don’t know what’s going to happen. No one knows what’s going to happen. And in the last few years, we’ve seen an unusual amount of just huge, unprecedented things happening in the economy. And so whatever you’re doing, I do think you need to be prepared for it. Now, that’s not necessarily a problem. Some of those things are upside. We haven’t talked about ChatGPT and AI. Maybe those will raise economic growth a lot. In any world, people are going to need real estate, and that’s one thing they always need. But yeah, I think you just need to be prepared for uncertainty and make sure you’re protecting against the downsides and look forward to the opportunities that it throws up.

Dave:
Well, Jason, thank you so much for being here. This has been a great conversation, really enlightening and informative. We appreciate you being here. If people want to connect with you or follow you, where should they do that?

Jason:
Well, you can certainly follow me on Twitter, @jasonfurman, just the regular spelling of my name. There’s a lot of inflation tweets there. I should warn you in advance. It’s not for the soft of heart.

Dave:
All right. Well, thanks again, Jason. And hopefully we’ll have you back again sometime soon.

Jason:
Great talking.

Dave:
On the Market is created by me, Dave Meyer, and Kailyn Bennett, produced by Kailyn Bennett, editing by Joel Esparza and Onyx Media, researched by Pooja Jindal. And a big thanks to the entire BiggerPockets team. The content on the show On the Market are opinions only. All listeners should independently verify data points, opinions, and investment strategies.