Chief Economist, Goldman Sachs Group, Inc.
Vice Chairman of Investment Banking and Global Cohead of Healthcare, Lazard; Former Distinguished Visiting Fellow, Council on Foreign Relations; Former Director, Office of Budget and Management, White House
Chief Investment Officer, Bessemer Trust Company, N.A.
Paul A. Volcker Senior Fellow for International Economics, Council on Foreign Relations; Author, The Man Who Knew: The Life and Times of Alan Greenspan
Experts discuss trends in the global economy.
The World Economic Update highlights the quarter's most important and emerging trends. Discussions cover changes in the global marketplace with special emphasis on current economic events and their implications for U.S. policy. This series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.
MALLABY: OK, I think we can get started. Welcome to what I guess is back-to-school night for the economics program here at the Council, World Economic Update here with Jan Hatzius, Rebecca Patterson, and Peter Orszag.
I’m Sebastian Mallaby. I’m the Paul A. Volcker senior fellow for International Economics here at the Council. I guess I’ve been chairing these meetings for a while now, and I would say that, by way of introduction, this is maybe the moment when I’ve felt the best about the world economy since I can remember doing this. Maybe that makes me into a—I’ve just put a bullseye on my—on my stomach—(laughter)—I’m a contrary indicator.
But what I want to do in this meeting is get a sense from my friends here on the panel about how—whether they share this sense of optimism; whether they share the idea that essentially, if you go back to after the election here in November, you had a sort of Trump bump, which felt a bit like a burst of optimism running on fumes, unless you believed that the president would be able to deliver all those promises. But now, instead of that, you’ve got a much more diversified growth story, with much of the positive news coming out of Europe, a bit of China, a bit of Japan. It feels like a pretty broadly spread good-news story, with not just the U.S. market up but global markets up more than the U.S. year to date, and the world economy in the second quarter growing at over 4 percent, which I think is the best since 2010.
So that’s what I’m trying to test with you guys. Jan Hatzius is the chief economist at Goldman Sachs. Rebecca is chief investment officer at Bessemer. And Peter is managing director—have I got that right?—at Lazard.
And we’re going to start here with Jan and the U.S., drill down on the U.S. a bit. So the forecast here in the U.S. is for growth still a bit over 2 percent. Has that changed at all because of the hurricanes? Do you expect that a sort of burst of rebuilding affects that number? How do you see the upside-downside risk on this?
HATZIUS: I don’t think it changes a lot, I mean, in terms of the quarterly numbers. Q3 is going to be weaker because of the hurricanes, just because of disruption effects. We were close to 3 percent. We’ve taken that down to 2 percent. And, you know, that builds in a, you know, reasonably limited effect from Irma, a damage estimate of about $30 billion. That would compare with probably something, the 60 (billion dollar) to 100 billion (dollar) range for Harvey.
But I do think there will be some significant disruptions. I don’t know if you’ve looked at a map of Walmart stores in Florida and surrounding states. Every single one of them is shut. So I don’t think that that’s, you know, going to matter a lot from the perspective of where we’re going to be six months from now, but I do think it’s going to have a negative impact on Q3. We’ll make all of that back in subsequent quarters, and then probably a little bit on top of that for rebuilding—rebuilding activity.
So the net is probably slightly positive in terms of GDP, which, of course, tells you that GDP often doesn’t really get at what matters. And, of course, people in the affected states are much more worse. There’s really a lot of disruption in many places. But GDP will end up being a little higher probably.
MALLABY: And just broadening out from the weather for a minute, when you’re—let’s go just right before the weather. The forecast was, for the third quarter, 3.
HATZIUS: Close to 3 percent. And we thought that things were probably going to gradually decelerate. The reason, I think, why the economy has been growing quite strongly recently is a much more positive impulse from financial conditions than what you saw in early 2016.
Early 2016, the tightening of financial conditions over the prior year had probably taken away a percentage point or so from growth. That was mainly the impact of the dollar appreciation, but also weakness in equity and credit markets. And that basically turned over the subsequent, you know, year to 18 months. So that gave the economy quite a lot of momentum. It’s still giving the economy quite a lot of momentum, growing around 3 percent.
We think that as we get into 2018, that momentum is going to slow somewhat as the financial conditions impulse diminishes. But that would, in our forecast, still leave us, even after the hurricanes, at 2 percent or a little more, meaning that we’d probably still be seeing downward pressure on the unemployment rate and still see above-trend growth. And now we’ve added a bit to the next few quarters, basically, because of the hurricane effects.
MALLABY: And one more follow-up for you. What are you assuming in policy terms? Does this assume a tax cut comes through late—this is not Q3, but beyond that?
HATZIUS: We are not really assuming anything significant.
HATZIUS: I mean, we kept downgraded the probability of a tax cut to below 50 percent. It’s still possible, but it just seems less likely to us. Even if it were to happen, we doubt it would make that much of a difference. I mean, the sort of numbers that one might see if it did happen would be perhaps half a percent of GDP in terms of the level of reduced tax revenue and perhaps increased spending in a few places.
That—if it’s spread over a couple of years, and if the multiplier is relatively low, as I think it probably would be, we’d be talking maybe a tenth or two tenths at the most in terms of additional growth in 2018.
MALLABY: And so, Rebecca, let’s bring the Fed into this picture. So the weather hits at a time when, both in leadership and personnel terms, and in policy terms, the Fed was in a tricky position. Obviously, Stan Fischer’s earlier-than-expected departure means that you’ve got to post people actually in those seats in terms of Fed governors.
And do you think this starts to weigh on the market, the sense that you’ve got three out of seven governors there only at the time when they have to think about, you know, complications from the weather, but more significantly the whole question of tapering, which they’re going to bring up at the meeting next week?
PATTERSON: So historically we have seen investor anxiety about Fed personnel weigh on the markets for tactical periods. August 15, when there was a lot of conversation about who would replace Bernanke, there were other factors weighing on the markets then. But I think Fed nerves, if you will, did influence that, although it was very short-lived.
I wouldn’t be shocked if there were some tactical volatility in the market tied to this. But I think overall the Fed is a consensus-driven body. It’s not a dictatorship. When you look at the candidates that are being considered, it seems unlikely, to me at least, that you would have some sudden shift in policy material enough that would affect markets in a sustained way. I think the policy side of it is much, much more important, and always is. It seems that the Fed is definitely moving ahead with starting balance sheet reduction at its meeting this month. You know, in contrast to the taper tantrum in May 2013, where you did see a 6 percent selloff in the SNP, almost 15 percent off in emerging market equities, in part thanks to a rise in yields in the dollar, this time around the Fed has communicated this so far in advance and so clearly that I think the potential for market disruption around September’s announcement is much, much smaller.
I think also you’ve got a stronger economy today than 2013, as you said at the beginning. You have stronger corporates today, reflected in earnings. So you just have a better backdrop for the Fed to start this. But it is an inflection point, you know. And so I think over time we’ll look back at this moment and say: This was important. But to your point on hurricane and personnel, at the margin I think it does create more risk the Fed goes slower, longer on rate hikes. They’re not going to have visibility on the data for the next couple months. It’s going to be very messy. It’s going to be hard for the Fed to discern the trend. And do you want to make a lot of change while you have so much personnel in flux? So at the margin I think there is a greater chance that we don’t get a December hike and maybe even a little less next year. The market’s already discounting that. So there’s not a lot of market reaction to be had there, but I think that is—it does affect the path of rates.
MALLABY: So, Peter, just to push a bit on this personnel side for a second. You’ve been involved in the past in White House processes for selecting people to the Fed. I mean, clearly it’s right, as Rebecca says, that the names that have come up as Trump appointees—Randy Quarles, Marvin Goodfriend—these are reassuring kinds of names, I’d say, broadly. But do you ascribe some kind of outside risk that the process sort of doesn’t work? You know, they don’t get around to thinking about it. The person who’s supposed to be running this process of finding the next Fed chair is the person who’ve fallen out of favor since Charlottesville. Does that pose some kind of tail risk?
ORSZAG: Sure. Look, just before we get to the Fed we have to remember, there are just under 600 Senate-confirmed appointments that normally an administration will fill. Of those 599, more than 300—320—still have not had anyone proposed or nominated for the position. So this is a personnel process that is wildly off track relative to what one would expect. I would note further that embedded in all these articles about the drama over Gary Cohn was a little snippet saying that he is perhaps no longer leading the process of picking the next Fed chair, and instead it’s an official in the personnel office. This is not a position that you normally turn over to the White House personnel office to choose. It’s a highly technical question. And normally it’s run either by the Treasury secretary of the NEC director, or someone who has substantial experience with the personalities that are under consideration.
If you combine that with all of the other things that are happening, which perhaps we’ll turn to in terms of, you know, what is likely to happen in December, distractions with the FBI investigation, North Korea, and on, and on, and on, it is entirely plausible that this just doesn’t actually get going in terms of picking someone and they wide up either with a very rushed process at the very end of the day, or they wind up just going with the status quo because it’s easier.
MALLABY: So the status quo would be reappointing Janet Yellen.
MALLABY: How does that sound to you, Jan? Do you—(laughter)—no, not do you like it—
HATZIUS: It sounds quite good, I believe. (Laughter.)
MALLABY: But what about as, say, a forecast as opposed to a—
HATZIUS: No, I think—look, I think that’s a very—that’s a very possible outcome. I think it’s very difficult to say at the moment. You know, it looked like things were converging towards Cohn at one point. Certainly, you know, looking at markets and surveys, that’s what seemed to come out. And now it’s a much more open question again, and obviously there are a number of contenders that have been bandied about for quite a while. But a reappointment, yeah, it must have gotten more likely.
ORSZAG: Can I add one other quick point, which is the person that Donald Trump wants in this position is not the person that a traditional Republican president would want in this position. Donald Trump seems like—again, this is another manifestation of not being a traditional Republican—to actually, despite what he says, be much more in favor of basically expansionary monetary policy than someone perhaps even to the left of Janet Yellen. And I raise that only because his newfound triangulation strategy of working with Democrats, which has gotten a—at least, it’s very early—but has gotten an initial positive feedback loop in the Trump worldview of generating positive press, and therefore maybe is a path that we’ll see, you know, further steps along, might reinforce that. In other words, if you’re trying to pick up Democratic votes as part of this new strategy of working with Democrats and putting pressure on the Republican leadership, the people you would choose might be slightly different than the list that is often bandied about as kind of traditional Republican Fed chairs.
MALLABY: It might depend, presumably, on which type of Democrat one is talking about. With Chuck Schumer, you have a New Yorker like Trump, a dealmaker like Trump, a press hand like Trump. You know, this is, I can see, a marriage that could last at least a few weeks. (Laughter.) Janet Yellen, I don’t think, ticks these boxes—a sort of, you know, press hand, dealmaker, New Yorker. She’s more of a different kind of figure.
But, Jan, I want to ask something else, which is, you know, as you remarked earlier, financial conditions are very, very loose, notwithstanding some policy tightening. And so we’re in this environment where you have some policy tightening, you have full employment, and yet because of the behavior of financial markets and the currency conditions are loose. Does this feel a bit like the conundrum of 2005, 2006? And if so, is that good, bad, worrying?
HATZIUS: I think it does a bit, although they are—I mean, the reasons are always a little different. But I think recently the biggest driver of the easy financial conditions have probably been the weak inflation numbers. And, you know, we’ve had a string of downside surprises. We’ll get another number this week. I think ultimately for me this is not as important an indicator of where the business cycle stands as the labor market numbers. I think the labor market sent the correct message back in 2011 when core inflation was rising that we were still really far away where we needed to be. And I think we’ll ultimately find the now, again, the labor market will send—will have found—will be found to have sent the correct message that we’re now basically where we need to be from a cyclical perspective.
MALLABY: Just to be clear, you’re saying inflation targeting is a mistake?
HATZIUS: I’m saying that one shouldn’t put too much weight on inflation alone. I think putting some weight on inflation makes sense, but I think a dual mandate, a multi-indicator approach to where the business cycle stands is better. If you were single-mindedly focused on inflation you would have argued—as obviously some people did—back in 2011 for really exiting. And I think that would have been a really grave mistake.
MALLABY: So, Rebecca, you’re the one on the panel who actually deploys money. And do you worry about bubbles at this point because of this confluence of, you know, low inflation, which allows a central bank that still thinks in an inflation-targeting way—to at least some degree—to be probably looser for longer? And then you get, you know, a situation of full employment. The money is going somewhere. It’s not creating inflation, but it’s creating asset price inflation. Do you see that as a danger down the road?
PATTERSON: Yes, I definitely do. You know, if you ask me is there a bubble today and if so where, you know, I think if there’s one that’s starting to inflate, or the one that keeps me up at night the most potentially, it’s probably in the high yield market here in the United States. You know, this year U.S. companies—they’ve already issued about 750 billion (dollars) in debt. They’re on track to break a trillion for the third year in a row this year. Defaults are still extremely low. But if or when we get to a point where we have inflation and/or there’s other reasons the Fed wants to start raising the cost of capital again in a faster way, I think it’s—it is an area of growing vulnerability that could have almost instant feedback loop effects on the stock market.
So it really does come down to yields, and inflation as a primary driver of yields, rightly or wrongly. So, if inflation stays low and yields can stay low, the party keeps going on and on and on. If inflation picks up, maybe because of fiscal stimulus, or because of other reasons, maybe, eventually, dollar feedthrough, et cetera, and the Fed decides to take advantage of that and tighten to try to normalize interest rates, then I think there are some bubbles that potentially could be popped. And I’m not trying to say they’re similar in magnitude to what we had in 2007, but they are growing. You know, debt on corporate balance sheets, when you look in the aggregate, doesn’t look too horrific today, but that’s—if you take out financials, who have clearly de-levered since the crisis, nonfinancial corporate debt is back up to pre-crisis highs, and you are seeing more covenant-like loans and that sort of behavior. That’s an area of growing risk, in my opinion.
HATZIUS: And if I can just jump in here, I think it’s not just about the financial markets potentially overheating, but it’s also—I think that if the—if the expansion in the labor market continues, the risk grows that eventually you will be below the unemployment rate or, you know, U-6 rate, or whatever your favorite indicator of labor market slack is—below the rate that you can sustain in the long term. And it may be that you only find out after, you know, a year or so. If you’re—if you’re below where you can be in the long term, unemployment rate has to rise, and historically, it’s very difficult for the Fed to increase the unemployment rate without a recession. There’s never been an increase in the U.S. unemployment rate of more than a third of a percentage point that wasn’t associated with the recession. So, you know, of course, nobody knows where that level is exactly. Estimating structural unemployment rates is very difficult. Right now, the Fed’s estimate is 4.6 percent. That could obviously turn out to be too high. But the risk is definitely there, and I think I would put it alongside the financial imbalances as a—as a potential risk—
PATTERSON: And just to close the loop, you know, to the degree the unemployment rate keeps going down, eventually, in theory, we should see a little more pass through to wages. But if companies don’t feel they can pass those through, then the risk is profit margins get squeezed. So that could be another risk for equity markets to watch.
MALLABY: Let’s go to Washington again.
Peter, you’ve already laid out the triangulating White House possibility, but we’ve also got the functional White House possibility, the John Kelly, Kirstjen Nielsen, more disciplined operation. And putting those two together, do you think that tax cuts, tax reform are more likely or less likely now?
ORSZAG: Less likely. So, first—the first thing to say on tax reform is, it’s really easy to say and it’s really hard to do. So it’s the kind of thing that’s always attractive at this level, and then when you get into the details, all of a sudden it gets a lot harder. I think the odds of significant tax reform, or even tax cuts, coming back to Jan’s earlier point, have declined more than the market realizes over the past month or so, and that’s for multiple reasons. First, to the extent this triangulation strategy is effective—and again, the president enjoys the positive glow of press saying that things are happening, and that he’s cutting deals with Democrats—this is not going to work on taxes. What the Democrats want on taxes and what the Republicans want on taxes do not overlap basically at all. It instead leads you back to things that were on the campaign trail—things like infrastructure, drug pricing and so on. That’s the triangulation path, not tax reform. Corporate tax changes are not going to be part of a triangulation strategy. That’s a first point.
Second point, to the extent that the complexities around Gary Cohn’s future lead him to depart sooner rather than later, if he were to leave, I think that’s another significant blow to the prospects for any corporate tax changes.
Third, you have the DACA developments. It is interesting to me that the CEO of Microsoft has come out and said while we favor tax changes, that’s a nice-to-have, and the DACA legislation is a must-have. So we need to put DACA in front of tax—corporate tax changes, further pushing the corporate tax thing down the pike. And then you have the complexity around the deal that was just struck, which it pushes a lot of hard decisions into December. It’s implausible to me that you’re going to get the tax stuff done before the debt limit and spending bills and what have you come back into play in December. You put that all together, and it’s just hard for me to see how this hangs together—except perhaps a very targeted narrow thing involving deemed repatriation and some modest reduction in corporate rates sometime next spring. But that’s a, you know, very skinny package relative to what was initially expected.
MALLABY: So something what I think I’ve heard on the U.S., I mean, we’ve got a situation where growth reflected, to some degree, these very loose financial conditions. These loose financial conditions can’t probably last. If they were to last, they would exacerbate these bubble risks that Rebecca talks about. And meanwhile, things like tax reform don’t necessarily seem more likely.
So let’s go to Europe—(laughter)—where this—the shift of the good news has taken place.
Rebecca, European—eurozone growth in the second quarter was 2.2, so that was the upside surprise.
PATTERSON: Mmm hmm. (Affirmative.)
MALLABY: And I guess the question is, you know, is that sustainable? And you could—I guess you could start by asking whether ECB tightening ends all this, or whether there’s a sort of political honeymoon going on. Right as we all sat down and began this meeting was exactly when the French union was—the labor union was going to the streets to protest against Macron’s labor reforms in France. Two-thirds of the voters in one poll I saw share the view that labor reform is a bad idea. So I don’t know whether you want to take a political cut at this, or a central bank cut at this, or both, but how do you feel about the sustainability of this spring in Europe?
PATTERSON: I mean, the good news is, survey soft data, leading indicators for Europe are continuing to strengthen and broaden out. So if you just look at manufacturing or service sector PMIs, you know, seven, eight months ago, you had a lot of things just bordering on expansion, and they’ve continued to strengthen. And certainly that suggests in the short term this momentum can continue. The ECB, I think, is in an incredibly difficult spot in that it wants to seize on this moment of good growth while it’s got it, because it doesn’t know how long it lasts, it doesn’t know how long the political honeymoon lasts, so to speak. Italian elections look a little better right now for next year, but that could change. It’s Italy. I say that only because I lived there, and as a journalist in my previous life I covered Berlusconi’s first election. So I have good anecdotes behind my statement.
HATZIUS: When it all turned south.
HATZIUS: When it all turned south.
PATTERSON: Yes, exactly. (Laughter.)
Anyway, so they want to use this economic backdrop to start moving on monetary policy, which makes a ton of sense. And they are literally running out of bonds to buy for their asset purchase program. They could try to change some of the rules to give them a little more time, but the time is limited. So tapering seems inevitable, and yet the euro is doing a lot of the tapering for them. The euro against the dollar is up almost 14 percent year-to-date, and on a trade-weighted basis a similar amount, and so that’s tightening financial conditions, working against their inflation goal. So that’s making—have them less need to tighten.
And in a country like Germany, which Jan knows better than I do, you know, your economy’s 50 percent-ish exports. So the euro matters a great deal, politically and economically. So how do they square the circle? How do they start tapering without pushing up yields and lifting the euro further, which can undermine their economic and inflation goals? And one thing I hear them discuss a lot is can we divide them. We can taper and start slowing purchases but signal to the markets that actual interest rates will stay negative/low for an extended period to try to manage yields and the currency. Draghi is trying now to verbally actually go after the currency directly, so far with very little success. So I think they have a real challenge. But my guess is they’ll continue to verbally intervene to try to manage the euro from strengthening further. I think they may have some success at that. But if they taper, it’s difficult to see yields in Europe not rising some. So I don’t think that undermines the economy any time in the short term, but it is going to be difficult to see this sustained in the long term if the tapering continues without some good news there. Maybe Marcon and Merkel are the new good news. I don’t know.
HATZIUS: I think—I think that strategy makes a ton of sense, actually: you know, taper QE very, very slowly but get going on it at some time in the—you know, in the next few months, maybe early in the new year, but at the same time we reinforce and maybe further extend the forward guidance. And they’re moving in that direction. I mean, looking at the press conference I guess last week, there was a lot of emphasis on a pretty lengthy interval between the last QE operation and the—and the first hike in the—in the deposit rate. We’ve also found, as it happens, that the path of the policy rate is actually more important for overall financial conditions and, therefore, real economic activity than whether you, you know, you buy somewhat more, buy somewhat less, you know, in terms of government bond purchases.
And I think there’s still a strong case for the ECB to run a very accommodative policy, not only because of the euro appreciation and the moderate tightening in financial conditions that you’ve seen in Europe, but also because, you know, the European unemployment rate is still over 9 percent and while core inflation has gone up a bit, it’s still well below the target, so really unlike in the U.S. where, you know, the inflation data tell you one story, but the labor market data tell you another. In Europe, it’s all relatively straightforward from at least an aggregate, sort of average perspective. This is still an economy where monetary policy should really remain highly accommodative for a while longer.
MALLABY: But just one question on that, Jan. So in the past, a big perceived factor on the European central bank’s ability to deliver supportive monetary policy was German opinion, German politics, German pressure. We have this election now on September 24th. Merkel seems very likely to win. The shape of the coalition could go either way, so-called Jamaica coalition with the Greens and the Free Democrats as one possibility, continuation of the status quo as another one.
But I guess the question is for you, you know, we have this situation where, as you say, unemployment in the eurozone is 9.1 (percent), but unemployment in Germany is 3.7 (percent). So from a German perspective, you know, will there be a sort of renewal of pressure from Germany on the ECB to reign in?
HATZIUS: Yeah. I mean, Germany has a more hawkish view. Germany is generally not in favor of Keynesian economics. There is, you know, deep-seated skepticism of anything that looks like a quick fix. And, you know, I think that’s, in many ways of German economic policy, that’s a good thing.
I think as far as monetary policy is concerned, sometimes the right answer actually is the quick fix when it comes to the short-term fluctuations of the business cycle. But it is what it I, that is the German view. I think there will be resistance against, you know, highly accommodative policies from the ECB. That said, it’s been a fact of life for a while. And I think if you get going with the tapering, even if you do it at a slow pace, but if you put the asset purchase program on a path to extinction maybe sometime late in 2018, I think there would be some willingness to, you know, see the continued, very low interest rate policy, negative interest rate policy as far as the deposit rate is concerned, as a price that one might be willing to pay.
So I don’t think it’s going to, you know, fundamentally change the debate. We’ve had these debates for many years.
MALLABY: Peter, you’re a euro optimist or not?
ORSZAG: Well, much more so today than two or three years ago. And a couple of points. One, we are all benefiting from the fact that the French political opposition to Macron is in shambles on both sides. His popularity rating has fallen to 30 percent, but he’s still able to proceed, especially on the labor reform, because the two parties on both sides have no credible alternative right now.
So normally at a 30 percent popularity rating you can’t get much done. Let’s all hope that he is able to push through on the structural side the reforms that they’re talking about because that’s one of the linchpins for the sense of optimism. That’s the first point.
The second point I’d note is I agree that as of right now the major risk factor involving the Italian elections looks OK.
ORSZAG: But you never know.
ORSZAG: And it is interesting to me, for example, that the concern that the emails that were apparently hacked from the German parliament have not become a major issue in the German elections. They haven’t been released. We may not have seen, though, the end of that sort of activity in elections. And one might suppose that emails among German parliamentarians don’t involve that much interesting information. I would suggest in the Italian election context it might be a completely different story. (Laughter.)
MALLABY: That is where we’ll have to get Rebecca off the record at some point.
Well, I want to get one question on China in before we open it up to members’ questions. Perhaps I’ll put this to Jan since you’re the one whose turn it is.
You know, there’s been talk of the great leap backward; in other words, rather than industrializing aggressively as it did with the great leap forward, China has actually done something about overcapacity in coal and steel. And that’s had a ripple effect on the price of those commodities, which has, you know, been supportive to some inflation to nominal growth in China and that’s rippled internationally.
The question is whether that’s, you know, going to be sustained if you put together the fact that we know with the Chinese economy growing faster, maybe the capacity tightens because of demand-side stuff. Maybe the political will doesn’t get sustained around telling coal mines not to be mined for more than 270 days a year. How do you see China, which we all sort of thought of as a big risk factor for the world economy a year ago and now is supportive, does that sustain itself?
HATZIUS: I mean, I think the trend for Chinese growth is probably downward over the medium term. We were in a, you know, probably only a 5 percent or so growth environment, you know, a year or two ago. The official GDP numbers were still close to 7 percent, but when we looked at other indicators and tried to extract a message from that through the, you know, various aggregations, we were basically at 5 (percent). Now the official numbers and the sort of higher-frequency, more-reliable indicators are roughly the same, all in the high 6s (percent).
You know, over the next few years, I think from a supply-side perspective, growth is going to slow. You know, even outside of what they do about overcapacity in industrial sectors, from a demographic perspective we’ll see a gradual slowdown.
We think after the party congress there probably will be a desire to bring down debt growth to a more sustainable pace as well, so I think that’s probably also going to weigh on growth. And before too long, my guess would be that the nervousness about the downside risks reemerges again. You know, it’s been very much a sort of stop-go process and we’ll probably see more of that. But, you know, I’m thinking kind of 6 percent a few years out, maybe 5 percent, not 7 (percent).
ORSZAG: Not in the higher landing. And I think we also need to realize how massive the adjustment has been in steel and coal. I mean, employment has fallen 25 (percent) or 30 percent since 2013, which is, you know, over a four-year period a pretty huge adjustment.
The only other point I’d make, I agree with Jan that we should expect some deceleration, but not the kind of hard—I mean, I think the real debate is not will there be somewhat slower growth in China over the next five or 10 years because one would expect that. The question is, what is the probability of the hard-landing scenario, which is, I think, where the fear has been.
And my own view is that, while it’s not zero, it’s pretty minimal, both because the authorities are well aware of the vulnerabilities, especially with regard to SOE debt, and because they still have, despite some fiscal expansion over the past few years, they still have plenty of operating room to address problems as necessary. So if you put those two together, you can never rule out the hard-landing scenario, but I think that’s the real debate, not whether growth falls by 50 basis points or not.
MALLABY: So let’s get members to join in the conversation. Remember this is on the record.
We have a question first of all right here. Thank you.
Q: First of all, thank you to the panel. My question is to—
MALLABY: Could you say your name?
Q: Joe Cari, Medcap Funds.
My question is to Rebecca and Peter. If the present administration elevates a trade war with China, first of all, do you expect that? And if it happens, what are the economic ramifications for the market and the American economy?
ORSZAG: So I’ll take this first. I think one of the dangers, I didn’t highlight this, one of the dangers in this new triangulation thing, which, again, I don’t want to exaggerate too much, but there is a positive feedback loop, so the more the press says, oh, this is so great, the more the president is going to be attracted to this mode of governing.
In general, I think it’s a good thing. The one big risk factor is one of the items I didn’t put on the list but would definitely fit into the triangulation strategy is on the trade front. So to date I have been skeptical that we would see anything beyond the kind of sectoral approaches that the administration is already deploying, so in steel as one example.
I would still suspect that that’s going to be the dominant form of trade intervention over the next few years, which is using existing authorities on a sectoral basis to kind of scratch the itch, as it were, of protectionism without ripping up trade agreements and revisiting things writ large. And that’s both with regard, frankly, to NAFTA and with regard to China and others.
To the extent that triangulation kind of picks up speed—and I am not where—I mean, I think there was an absolutely ridiculous New York Times article saying this is a new mode of governing and we’re kind of there—that’s not—I mean, there was one mini-deal, and we have to wait and see how much this gets entrenched. But if it does, I would say it raises the odds of a protectionist trade kind of thrust being part of that.
PATTERSON: And I guess I’d add, when this administration first came to be, given all the campaign rhetoric, I was extremely nervous about the possibility of a bigger trade war and have been delighted to see that it’s been much more focused, targeted, nuanced, in terms of areas going after it.
I think one near-term area of focus for me is because of the dollar weakness that’s come alongside lower yields, lower inflation, the flip side of that has been a much stronger renminbi. So the renminbi has gained about 6 percent year to date against the dollar, to the point that the Chinese are starting to intervene again to prevent it from strengthening further. And you see that reflected in their foreign-exchange reserves going up a little bit.
If that were to continue—I don’t think it will continue at the same pace, because I don’t think the dollar will keep falling at this pace—but if it were to continue, then you could start having members of Congress, different lobbying groups, manufacturing sectors, pushing again for the U.S. to take hard steps against unfair trade practices by China. So that would be another catalyst potentially for greater trade action.
So it’s something to keep an eye on, because we haven’t seen this for the last few years. This is something new that’s just emerged in the last few months. I think the Journal had an article on it yesterday. It was the first mainstream press I had seen about this so far. So it’s not something that a lot of folks are talking about, but I think it’s worth keeping an eye on.
MALLABY: Incidentally, my colleague at the Council, Brad Setser, has written about how this is not just China. This is actually several different Asian countries back to reserve accumulation recently.
Yes, let’s go over here and then we’ll go to—
Q: Esther Dyson from Wellville.
This is sort of the opposite of the quick fix, but I remember sitting here two years ago when Angus Deaton was talking about the opioid—it wasn’t, quote, a crisis yet. Two, three days ago, the Wall Street—The New York Times had a piece noting that there was at least some question—to me it seemed kind of obvious—that some of the decline in labor-force participation was due to white men on painkillers.
So I’m just curious what you think about the impact on the quality of the U.S. workforce, both of our education system and all the stuff going on in the lack of health care.
MALLABY: Peter, also, there’s new income and poverty numbers out today.
ORSZAG: Yeah, so both.
MALLABY: Maybe you can—
ORSZAG: So first there’s some suggestive research—it’s not conclusive—from Alan Krueger at Princeton on the connection between opioid use and decline in prime-age-male labor-force attachment. I’m sort of with you in the sense of the timing kind of fits. And it, again, makes intuitive sense. It’s very hard to hold down a job if you’re addicted to opioids.
And what’s interesting about that is then that creates a pretty nasty feedback loop, because the evidence suggests that one of the reasons for this epidemic is that prospects for middle-class Americans have not lived up to expectations. That leads to depression, anxiety, and other afflictions. People turn to painkillers as an escape, and then they further diminish their economic prospects.
One slight—and, by the way, consistent with that, I mean, something that doesn’t get enough attention is that life expectancy for 50 to 70 percent of white Americans at the middle to bottom of the socioeconomic distribution is at best flat, and it’s probably declining, which is really astonishing in the world’s leading economy.
Slight good news. Sebastian mentioned that income and poverty numbers are out today. If the median income number exceeds—I think it’s 1.2 percent—given how strong the real median increase was last year, that would be the most rapid two-year increase in decades. So these things often lag.
And to Jan’s point earlier about strengthening labor market, it’s not fully showing up yet, but there are some signs that, at least with regard to real median income, while it has underperformed relative to what, A, people expected; and, B, what has happened to the overall economy over the past two or three decades, there’s a little bit of sign of hope that the strengthening labor market may help attenuate some of the pressures. But that’s a—you know, a very small point on a much larger story.
MALLABY: And there’s one over here. Yes.
Q: Good morning. (Inaudible.) Thank you all.
A question on inflation expectations and the absolute level of rates in the U.S. Two of the markets where we’ve seen some tightness in the U.S. are around construction jobs and around certain resources relating to construction. What impact, if any, do you think that the rebuilding around Florida and Texas due to the storms could have on inflation expectations going forward?
HATZIUS: I mean, I think it’ll have some impact on overall actual inflation, more on the headline side probably than in terms of the core numbers. You know, looking at past natural disasters and the inflation numbers around that kind of by category, we do find some effects. But they’re generally relatively small, I mean, in the sort of five-basis-point-for-the-core range; maybe 20 basis points for the headline numbers. Over the next couple of months we’ll probably see that.
In terms of inflation expectations, as in, you know, what the markets are discounting, what consumers are saying, I suspect there will be, you know, probably a short-term spike in some of the surveys. But I don’t think it’s going to have a major effect on the—you know, the longer-term five- to 10-year inflation expectations that you see, for example, in the University of Michigan monthly survey.
You know, I think best guess is that, over time, core inflation is going to move somewhat higher as we see more of an impact from the tightening labor market. But that’s a very slow process and not a very reliable one. The Phillips curve is very flat. A one-percentage-point move in the unemployment rate is only worth 10 to 15 basis points on core inflation. So there are lots of other things going on in the inflation numbers that could overturn that. But, yeah, best guess would be inflation does move towards the target.
MALLABY: Yeah, here in the front.
Q: Puneet Talwar with Crest International.
I was wondering if, just for anybody on the panel, if you could comment on the outlook, especially medium to long term, for the oil-rich or oil-dependent Middle Eastern economies and how you think they are adjusting to the new lower-price environment.
MALLABY: Who wants to take that? (Laughs.) Nobody? We had a discussion before about the geopolitics of the Gulf, but not really about the fiscal—
PATTERSON: May I? I can start.
PATTERSON: You know, obviously, Saudi Arabia has been very public with its efforts, under the changing demographics within the monarchy, to make a new attempt to try to diversify its economy so it’s relatively less reliant on oil. But that is a very slow-moving process, relatively speaking. So oil still is the key driver, I think, not only for that economy but the region.
And so, I mean, first of all, trying to predict oil, I think, is one of the most challenging things out there. There’s a reason that the IMF and the Fed and others just use the curve as their oil forecast inputs rather than trying to come up with their own model, because you get it wrong more than you get it right. It’s just really hard, because it’s not just supply and demand. It’s also geopolitics. It’s the dollar. It’s financial markets. So it’s an incredibly hard thing to know where oil’s going.
You know, I think Saudi Arabia in particular, given that they have gone from a surplus country to a fiscal-deficit country, with a young population that demands social support from the government, from the monarchy, they have to keep oil prices supported to the degree that they can continue to ensure social stability. So there is a bottom on oil price from that point of view that they will try to support.
Obviously, with the Aramco IPO next year, they’d like to get prices higher ahead of that in particular, to make that a successful venture. But then with technology in the United States, putting more production in the U.S. and creating the ability for us to ramp up supply on a global basis, puts kind of a cap.
So it’s putting us in this range. We know these ranges never hold forever. So it’s a matter of what is the catalyst for it to go below or above. And above, we were talking before our event today on another area of geopolitical risk that’s less in the headlines now—everyone’s talking about North Korea—we were discussing this morning briefly about Iran. And if you do get the administration pulling back from the nuclear deal with Iran, could that create some greater degree of instability in the region that could have effect on perceptions around oil supply over some point in time? I don’t have a strong view on that, but it’s definitely something to watch.
MALLABY: Let’s go to the back there.
Q: I’m Bob Hormats, Kissinger Associates. Bob Hormats, Kissinger Associates.
I wonder if you could comment on the sort of medium-term question of technology displacement of jobs. This is an ongoing debate, as you know. A lot of people are concerned that new technologies—particularly driverless cars, but a whole range of other things—will have a depressing effect on employment. And I was wondering if you could comment on that, and what it means for policy—particularly monetary policy.
HATZIUS: Yeah, I mean, maybe I’ll take a crack at that. So we have looked at the, you know, impact of technology on employment, of course. Generally, the finding has been that we can’t really find a clear impact on the number of jobs, on the levels of employment, on the, you know, likelihood that different—you know, different countries have high unemployment or low unemployment. Where we do find a very clear technological impact is on wages. And the, you know, distribution of wages sort of across the population, the, you know, middle-skill, routine, manual occupations have clearly suffered from technological displacement.
That could move into other areas—probably will move into other areas. Driverless cars and trucks is a good example. So I do think it’s something that probably will continue to widen the income distribution. Obviously, there are other factors that are important for the income distribution, but this is probably one that will continue to work in that direction. So for monetary policy, I’m not sure that it has a very big impact. But other government policies, fiscal policies, transfer policies, training policies, you know, there are some very clear implications that, you know, government is probably going to be more called upon to, you know, help those that are—that are negatively affected by it.
PATTERSON: And if I could just add quickly, two reports that I’d recommend for people interested in the topic. McKinsey, if you want to get really depressed, put out a really nice piece earlier this year where it was discussing the percent of jobs in each industry and defined by type of job that potentially could be automated. It doesn’t mean they will be, but they could be. And it doesn’t give a timeframe. But the numbers are staggering high. But it’s just good food for thought, which industries are more susceptible than others. And then also, I believe it was a Hamilton Project report recently that had a—I thought, a really good piece of work that showed the states in the United States that have the highest percentage of jobs per state in STEM industries, and tried to compare that to wage growth and overall wages in the state. And not surprisingly, the states that do tend to skew more towards STEM occupations tend to see higher wages overall, better economic growth.
MALLABY: I was going to mention Hamilton because, of course, Peter was the founding director.
ORSZAG: That’s true.
PATTERSON: Big fan.
MALLABY: And so I wondered if you could—on this—on the policy challenge that arises from this growing inequality in income because of technology, I guess there’s the kind of—the school that says, you know, stick to the playing book, progressive taxes, protect welfare benefits of various types that we have. And that’s—you know, if you can protect those things that’s enough. And then there’s the kind of universal basic income, sort of more radical blue-sky paradigm-shift type stuff. Where do you imagine in your sort of five-year view, if you—or whenever it is that there’s next an administration keen on this kind of thing—where does that land?
ORSZAG: So three points. First, I think we do need to make up our minds whether the core macro problem that we face and even distributional problem that we face is very sluggish productivity growth or the onslaught of automation, because those are exactly the opposite of one another. And they can’t coexist at the same time. And we seem to have kind of cognitive dissonance over which one—as many people have pointed out—which one’s the more pressing concern. Secondly, whether you go kind of big or you go traditional, the first thing is do no harm. And so in the current environment, the debate over, for example, the progressivity of the tax code I think is particularly important because it may be that you can’t make the situation that much better, but there’s also an argument you shouldn’t be making it worse.
Third point is, whether we go big or not is really at the heart of the debate that’s going to envelope the Democratic Party over the next few years, running into the next presidential election, because there are different factions within the Democratic Party. And this is one dimension in which that will manifest itself. And then finally, and perhaps most importantly, in all of this I think we have been neglecting the truly stunning results and new evidence suggest that firms adopt technology at different rates and in different ways. And the dispersion across firms in returns on invested capital, in productivity, in wage growth, et cetera, et cetera, et cetera, are massive.
We’ve been framing most of the inequality debate as a winner-take-all kind of phenomenon at the individual level. And I’d suggest to you that there’s a lot going on, perhaps sort of winner-take-all at the firm level. And so as one manifestation of that, if you listen to most of the media reports you would come away with the thought that the vast majority of the rise in wage inequality in the United States is within firm, the CEO earning so much more than that the typical worker at each firm. There have now been three studies using different data sets suggesting that’s wrong. The vast majority of the rise in wage inequality in the United States is between firms, not within them. That is Firm A on average is growing apart from Firm B.
Now, there might be lots of reasons why that’s happening. The janitors are no longer part of the firm and they’re at a different firm. And there’s a whole debate to be had about that. But my point is, we really need to get under the hood of why are some firms growing apart from other firms, because it seems to be effecting productivity, wages, capital returns, and so on and so forth. And it’s gotten very little attention.
MALLABY: And that links to concentration at the end. Maybe we’ll get one more question in. Right here, yes.
Q: Bhakti Mirchandani. I work at a hedge fund. Thank you for your insightful comments.
We spoke about—a little bit about China. We spoke about petro-economies. We partly covered Russia. But what about the other BRICS and emerging markets in general?
MALLABY: Let’s give this to Rebecca, and then we’ll close.
PATTERSON: Sure. You know, the emerging markets were lagging, I think a lot of them affect by the oil shock we in the past couple of years. Some of them had been hurt by the strength in the dollar that we saw immediately after the crisis, putting a lot of pressure on their currencies and their debt markets, a lot of capital outflows. That seems to be reversing now. We are getting strengthening leading indicators across emerging markets. I think looking at a set of them, with the latest global manufacturing PMIs, only South Korea was under 50, so marking the expansion point. And that was just by a hair. So you’ve gotten a broad improving trend across emerging markets.
We’re also seeing a huge amount of net inflows. When you look across financial markets today, you know, where you saw relatively better value—unless you’re a very brave soul and you want to buy a lot of Japan—the area out there that looked compelling, relatively speaking, maybe six, 12 months ago was emerging markets. So you had evaluation discount, you had a perception that growth was starting to turn around, that inflation was starting to peak, currencies were very cheap. So you’ve had this big move of money coming in this year. In fact, the biggest inflows we’ve seen since at least 2011, 2012, both in equality and debt markets.
The good news is it doesn’t look, for many technical data, that these markets are overly crowded. In my own view, even if the dollar doesn’t fall a lot more from here, I also see it difficult for the dollar to rise quickly again, perhaps unless we get some major repatriation legislation that concentrates that flow which I don’t know if that’ll happen. So if the dollar stays stable or weaker, that’s going to be helpful for emerging markets at the margin. Low yields attracts money to emerging markets. And the focus I have here on finance is so important because so many of these economies do get influenced heavily by financial conditions and what’s happening in their capital markets. So overall I’m more constructive on emerging markets than I have been on a while.
China’s obviously a wild card. You know, if China were to slow suddenly, if that 270 percent total debt-to-GDP ratio suddenly became an issue again, that’s a problem for a lot of these economies. And obviously trade wars could be a problem for a lot of these economies from a sentiment point of view. But generally speaking, I’m as constructive as I’ve been in some time.
MALLABY: Well, that’s a good upbeat—
PATTERSON: A happy note.
MALLABY: Yeah, an upbeat World Economic Update. Thank you all for coming. Thank you to Jan, Rebecca, Peter. (Applause.)