The year the economy stops being weird

Trade-offs are back

Photo by Rod Long on Unsplash

Hello,

Happy New Year, and welcome to Known Unknowns, a newsletter that is open to new models for a new year.

2024 outlook

This may sound like a cop-out, but I don’t like to make predictions. I am a risk economist, which means I accept that I don’t know the future, and instead try to spot vulnerabilities that may cause trouble or will blow up if trouble comes along.

That said, I have been making more predictions lately. And one I’ve made in the last few years is that we are entering a new regime of higher interest rates and inflation. It is becoming conventional wisdom that this view is wrong, and we are returning to the happy 2019 world of low inflation and low rates. In fact, inflation is already at 2%. Perhaps I would like to be wrong about that one; but I see several sources of risk that make that unlikely, at least in the long term.

I wrote about my  outlook for 2024 for Bloomberg. I argue that this is the end of the pandemic dividend. As pessimistic as I was about inflation and rates, I never thought we’d have a bad recession. The labor market was too tight and household balance sheets were too rich, both of which meant a more resilient economy. There’s lots of head-scratching these days about how economists got the recession calls wrong, and whether our models have failed. If so, should we use new ones and ditch the Phillips curve? Because it seems there is no trade-off between inflation and growth/employment after all.

I think of models of the economy a little differently than other economists (and some Wall Street economists and prognosticators who don’t use models at all). This is probably due to the fact that, when I did my PhD in macro at Columbia, they had several great macroeconomists there, but no particular intellectual orientation (it’s different now). So, I was exposed to many different approaches: Neoclassical, NeoKeynesian—and even some history of economic thought, but there was no view on which school was correct. And then I became a financial economist and less of a macro person, anyhow.

In the end, I look at economic models like maps; they are all flawed and inaccurate, but they can be a useful guide, nonetheless. And you have to use the right map for the right occasion; a map of Ohio does not offer much guidance for a drive through Florida in a hurricane. Moreover, in 2008, when household balance sheets were in the toilet from the housing bust and falling stock market, and there was more labor than jobs, a different model and policy was appropriate. I don’t throw out the Phillips curve just yet, but you have to be mindful when it applies and what the right slope is.

The post-pandemic economy was especially weird and very different from 2008, and it could be explained by different models than before. But I reckon the weirdness has run its course. That means the Fed might face actual trade-offs in getting inflation back to 2%, and we may be on a Phillips curve with a different slope. And in the long term, many deflationary forces are gone too, and we may face more supply shocks. This means the end of a free lunch for policymakers, so the Great Moderation models may also need to be revised.

Again, I don’t know the future. If there are no bad economic shocks, it may appear that we go back to 2019 without any economic pain. But the economy is less resilient than it was before. And in any case, people who are now arguing that we’ve learned from 2022–2023 is that inflation can be contained without any cost to employment and that we should pursue it in the future when we need to, are wrong.

Harvard

The last few months exposed many things that have gone wrong at elite American universities. Some have identified DEI as the root of the problem. I think it is a symptom of a bigger structural issue. The US economy and society are too fixated on a handful of elite schools.

Graduating from an elite school always offered a valuable signal to employers and social contacts. But in the last few decades the signal became both more valuable and less meaningful, at least to powerful subset of the population. This bestowed too much market power and too little accountability on a handful of universities. And power not only corrupts, it is bad for innovation, scholarship, and any pretext of meritocracy. It is not enough to demand more intellectual diversity, destroy DEI, and consistent standards on free speech. We need to get to the heart of the problem. Real change requires more competition in who calls themselves elite.

Here’s one for the pension geeks

It has been a crazy year for investors. Stocks are way, way up—thanks largely to the seven big stocks. And interest rates went up, then back down to where they were a year ago. And volatility often matters as much as the level. But all around, a good year for investors.

So, instead of the typical how to invest for retirement advice, let’s start 2024 with some retirement straight-talk or, three myths everyone gets wrong.

The biggest myth is that we are programmed to judge performance in terms of return. This is the original sin in retirement investing. Or the industry got good (kind of) at making money for rich people. Then we entered the DC world, and lots of middle-class people became investors too, and we just applied the same strategy. But if you are investing for income in retirement, you need a different strategy. And it involves a more sophisticated way to measure returns in income terms. It also helps people know how much they can spend each year, which is the whole point. This is not just in America; this has also plagued how we understand and reform other countries' retirement schemes. (Some good stuff here, but he lost me with alternatives because of the long investment horizon?!)

The fact that we’ve led everyone astray may be why everyone seems to think they have not saved enough. Don’t get me wrong, most of us should have saved more. But odds are, you are in better shape than previous generations, and they were alright, even if they did not live quite as long.

Third, Social Security is in trouble. We can’t ignore it and the longer we do, the more expensive and painful the solution will be. That said, the odds are retirees will still get their full benefits. They are a powerful constituency. And when push comes to shove, they always get their pensions. Everyone else: that is a different story.

Sad news

I am heartbroken that my editor at Bloomberg, Susan Warren, has died. She was a wonderful, warm, and exceptionally kind and generous woman. She was also the best editor I ever worked with—in many ways, more of a co-author. She brought out the best in me and made me a much better writer. Her influence is all over this newsletter, and I will miss her terribly.

Until next time, Pension Geeks.

Allison