Humble Forecasting, Hopeful Outlook

Episode Summary

Executive Summary: The episode centers on whether current inflation is mainly a supply shock or demand-driven, how that shapes Fed policy, and whether the economy can avoid recession. Justin Wolfers argues inflation should fade as pandemic and energy shocks normalize, warns that models/data are less reliable after COVID, and sees recession risk as real but overstated relative to momentum and persistent labor-market strength.

Main Topics: Inflation: supply shocks vs. demand (Priority: 5/5): Wolfers argues the inflation surge is better explained by supply disruptions, energy shocks, and pandemic-related dislocations than by excessive demand alone. He says these forces should dissipate over time, bringing inflation down without requiring a recession. Fed policy and the 2% target (Priority: 5/5): The discussion weighs whether the Fed should keep targeting 2% inflation or consider a higher target. Wolfers acknowledges the theoretical case for a higher target but says politics and credibility constraints make a near-term change unlikely. Labor market strength and hidden slack (Priority: 4/5): The hosts debate whether low unemployment and strong payroll growth imply overheating, while also noting that participation remains below pre-pandemic trends and that remote work may be substituting for wage gains. Measurement uncertainty after COVID (Priority: 5/5): Wolfers emphasizes that both macro models and economic data may be less reliable after the pandemic, since the economy’s structure, consumer behavior, and even what is being measured have changed. Structural shifts from remote work and deglobalization (Priority: 4/5): Marissa and Wolfers discuss possible lasting changes in labor markets, migration, productivity, and inflation from hybrid work, trade realignment, aging demographics, and shifting housing patterns, but agree the magnitude is still uncertain. Recession odds and forecasting humility (Priority: 5/5): The conversation closes with a live recession-probability game. Wolfers argues that forecasters are overconfident, sees recession risk as meaningful but not dominant, and favors a more humble, balanced-risk approach.

Key Arguments: Inflation is likely to fall as one-off supply shocks—pandemic bottlenecks, energy spikes, and Ukraine-related disruptions—work out of the system. A tight labor market alone does not fully explain inflation because wage growth has not kept pace with price growth in 2022. The public inflation experience is being driven by salient items like groceries and gas, so lower inflation would quickly feel much less severe. Pandemic-era changes may have altered how economists should interpret GDP, wages, housing, and labor data, making humility essential. A higher inflation target may have academic support, but changing the Fed’s target in the current political environment would be difficult and risky for credibility. Payroll growth remains exceptionally strong, but that does not automatically imply an imminent recession unless wage inflation and policy tightening spiral further. Remote work may be masking wage growth by shifting compensation into non-wage benefits like location flexibility. Recession calls should account for continued momentum and the fact that many economists systematically overstate downside risk. The Fed can make two kinds of mistakes—tighten too much or too little—but it cannot precisely engineer a soft landing with confidence. Structural shifts are possible, but the transcript suggests the magnitude and permanence of those changes remain unresolved.

Data Points: Dallas client dinner recession probability: 50% - Mark Sandy said Dallas clients were the most optimistic about recession risk among several cities. San Francisco client dinner recession probability: 70%-80% - Mark Sandy said San Francisco attendees were the most pessimistic in the dinner poll. GDP in first half of 2022: Small decline - Discussed as one reason some observers worried about recession, though Wolfers discounted it. GDI in first half of 2022: Increased slightly / generally more optimistic - Used to argue the economy was stronger than GDP alone suggested. Unemployment rate: 3.5%-3.7% - Cited repeatedly as evidence of an unusually tight labor market. Wage growth in 2022: 4%-5% - Mentioned as lagging inflation and therefore inconsistent with a pure wage-push story. Inflation in 2022: 7%-8% - Used to illustrate the inflation shock and the gap versus wage growth. Inflation outlook for end of 2024: 3.x% - Wolfers cited market and economist expectations that inflation would fall to the low-3% range. Payroll job growth: About 250,000-270,000 per month - Described as exceptionally strong by historical standards. Prime-age employment-to-population ratio: About 80% - Used by the hosts to suggest the labor market may still have slack or at least be unusual. University of Michigan one-year inflation expectations: 4.6% - Marissa cited the latest consumer survey reading, down from 4.9% last month. University of Michigan one-year inflation expectations previous month: 4.9% - Referenced as evidence inflation expectations are easing. Number of U.S. recessions in the last 100 years: 14 - Wolfers used this to argue that, absent other information, recession odds are not automatically high. Average recession length since WWII: About 10 months - Used in defining an NBER recession for the probability discussion. Non-manufacturing ISM index: 56.5 - Chris used it as a “good news is bad news” signal for strong service-sector growth. Prior non-manufacturing ISM reading: 54.4 - Shown as the earlier month’s level, indicating continued expansion. Months of non-manufacturing expansion: 30 consecutive months - Cited to show service-sector resilience. Recession probability estimates from hosts: Marissa 58%; Chris 70%; Mark roughly 40%-50% / slightly below 50% - The closing parlor game revealed differing views on recession risk.

Pivotal Quotes: "I don't think it's all demand." — Justin Wolfers: Wolfers’ core stance on the inflation debate; he leans toward supply shocks and away from a pure demand explanation. "The Fed doesn't get to choose where the economy is going, it gets to choose which mistake it's going to make." — Justin Wolfers: Used to frame policy uncertainty and the limits of central bank control in a highly uncertain environment. "We should be unbelievably humble." — Justin Wolfers: His central advice for economists and forecasters given post-COVID data and model uncertainty.

Implications: Listeners should expect inflation to moderate, but with policy risks and data uncertainty still high. The episode suggests recession risk is real yet not overwhelming, and that labor, housing, and inflation data may be harder than usual to interpret after COVID.