Jan Hatzius on the Narrow Path to Avoid a Hard Landing

Episode Summary

Executive Summary: The episode centers on whether the Fed can bring inflation back toward 2% without causing a recession. Goldman chief economist Jan Hatzius argues a soft landing is possible but narrow: supply-chain relief and lower commodity prices can help, but rebalancing an overheated labor market likely requires slower growth and some rise in unemployment. He expects disinflation in 2023, but only modest progress by year-end 2022.

Main Topics: Soft landing vs. recession (Priority: 5/5): Joe, Tracy, and Hatzius debate whether inflation can fall to target without a painful rise in unemployment. Hatzius says it is possible, but the path is very narrow and historically uncommon. What drove the inflation surge (Priority: 5/5): The discussion breaks inflation into pandemic supply shocks, fiscal/monetary stimulus, commodity shocks, Russia-Ukraine, and an underestimated labor-market imbalance. Labor market overheating and job openings (Priority: 5/5): Hatzius argues the key imbalance is not just unemployment, but the gap between job openings and available workers. He says reducing openings is preferable to layoffs because it cools inflation without hurting income. Wages, expectations, and Fed credibility (Priority: 4/5): The guests discuss whether inflation expectations remain anchored and whether wage growth is consistent with a 2% inflation regime. Hatzius says expectations are still well anchored, which is a major advantage. Rent inflation and the 2023 disinflation path (Priority: 4/5): Rent and owner’s equivalent rent are identified as major near-term upside risks, though Hatzius expects rent inflation to ease in 2023, helping core inflation fall. Global risks: Europe and China (Priority: 4/5): Hatzius warns that Europe faces a potentially deeper recession if gas supplies are disrupted and that China’s growth outlook is weakening again due to renewed virus impacts. Structural changes and the next decade (Priority: 3/5): The conversation expands to whether commodity tightness, aging, lower immigration, and post-pandemic normalization imply a lower growth speed limit and a more inflation-prone decade.

Key Arguments: Hatzius believes inflation can return near 2% without recession, but only through a narrow path involving slower growth and labor-market rebalancing. He expects the first stage of disinflation to be easier because commodity spikes and supply-chain bottlenecks are already easing. The hardest part is reducing inflation from roughly 4% to around 2%, which he says likely requires some labor-market softening. Job openings are a better gauge of labor tightness than unemployment alone because vacancies represent excess demand for labor. A decline in job openings is healthy; a rise in layoffs and unemployment would be much more recessionary because it destroys income and spending power. Inflation expectations staying anchored is crucial because unanchored expectations would make disinflation far more painful, as in the late 1970s/early 1980s. Rent inflation is a major near-term risk, but bottom-up lease data suggest it should moderate in 2023. Europe’s inflation problem is more dangerous because it combines high energy prices, weaker wage growth than the U.S., and financial fragmentation risks. The pandemic changed the economy by exposing the importance of detailed supply-chain, commodity, and labor-market data in macro forecasting.

Data Points: Headline CPI: a little over 9% - Hatzius cites current inflation as the starting point for expected disinflation Core PCE: a little below 5% - Used to illustrate how far inflation had already fallen from headline levels Job openings: close to 11 million - Evidence of an overheated U.S. labor market Unemployed workers: less than 6 million - Highlights the labor supply-demand gap Open positions decline: more than 1 million - Job openings fell sharply over the prior three months without a rise in unemployment Wage growth: about 5.5% year-on-year - Shows wages remain too hot for a 2% inflation regime Rent inflation: around 8% annualized - Recent rent and owner’s equivalent rent increases are a key upside risk Core PCE forecast for end-2022: 4.5% - Goldman Sachs forecast after upward revisions from rent pressure Current core PCE: 4.8% - Hatzius notes little progress expected for the rest of 2022 Core PCE forecast for end-2023: 2.5% - Expected deceleration as rents and broader inflation ease Fed funds rate forecast: 3.25% to 3.5% - Goldman expects a 50 bp hike in September and two 25 bp hikes in November and December Three-month average unemployment increase threshold: 35 basis points - Hatzius cites U.S. history showing larger rises have usually coincided with recessions Euro area wage growth: around 3% - Used to contrast Europe’s less overheated labor market with the U.S. China GDP forecast: 3.3% for the year - Goldman’s cautious outlook given renewed virus pressures China official target: 5.5% - Shows a sizable gap between forecast and policy goal

Pivotal Quotes: "I think it's possible, and I do think that there is a path towards something like 2% that doesn't involve a recession, but it's a very narrow path." — Jan Hatzius: His core view on the inflation-soft-landing question "Increases in unemployment and layoffs are a very different story. Then you do cut people's income, you impose hardship at the individual level, and you're also taking income out of the economy." — Jan Hatzius: Why falling job openings are preferable to rising unemployment "We now understand how little we understand about inflation." — Jerome Powell (quoted by hosts): Referenced by the hosts to underscore how hard inflation forecasting has been

Implications: Listeners should expect disinflation, but not quickly or painlessly. The key risks are wage stickiness, rent inflation, and any rise in unemployment. Europe and China add global downside risk, while the Fed likely stays restrictive through 2023.