The Bigger Worry: Growth or Inflation?

Episode Summary

Executive Summary: The episode examines whether a 2023 growth rebound could reignite inflation. Goldman Sachs’ Jan Hatzius argues U.S. growth should avoid recession and inflation should keep falling thanks to “freebie” disinflation from goods, supply chains, and rents. John Cochrane disagrees, saying inflation is driven more by fiscal excess than the Fed. David Rubenstein expects a higher-but-not-crisis inflation norm around 3% and sees private markets recovering as recession fears fade.

Main Topics: Baseline economic outlook: slower first half, better second half (Priority: 5/5): Jan Hatzius expects the U.S. to avoid recession, with sub-1% growth in early 2023, moving above 1% later and approaching trend by year-end. Why stronger growth may not mean higher inflation (Priority: 5/5): Hatzius argues inflation depends more on the level of slack/output gaps than on growth acceleration alone, especially if growth remains below trend. Disinflation drivers from goods, supply chains, and rents (Priority: 5/5): He says key disinflation sources are post-pandemic normalization rather than recession: lower commodity inflation, healed supply chains, weaker durable goods prices, and decelerating rent inflation. Cochrane’s fiscal theory of inflation (Priority: 5/5): John Cochrane contends monetary policy has limited power over inflation and that pandemic-era fiscal stimulus and unsustainable debt dynamics were the real inflationary force. Different views on inflation persistence and resurgence risk (Priority: 4/5): Hatzius sees inflation falling as temporary shocks fade; Cochrane warns that future fiscal shocks or debt doubts could trigger another inflation spike. Rubenstein on a higher inflation regime and private markets (Priority: 4/5): David Rubenstein expects inflation to settle around 3% for a while and argues that private equity activity and valuations should improve as recession fears recede.

Key Arguments: Hatzius expects the U.S. to avoid recession because growth should gradually improve through 2023. A faster growth rate is not necessarily inflationary if the economy is still below trend growth and slack remains. A large part of expected disinflation comes from normalization of pandemic-era price pressures, not from severe economic weakness. Rising commodity prices may lift headline inflation temporarily, but their pass-through to core inflation should be limited. Rent inflation should decelerate substantially because private market measures have already softened and official measures lag. Cochrane argues the Fed can raise rates, but it cannot fully control inflation because rate hikes mainly affect interest-sensitive sectors. He says fiscal policy matters because higher rates raise deficit costs and recession responses often bring more stimulus, offsetting Fed tightening. Cochrane believes the pandemic inflation episode was largely caused by about $5 trillion in fiscal transfers that boosted spending and money demand. He warns that if markets lose confidence in the government's long-run repayment ability, investors may flee Treasuries for real assets, causing inflation. Rubenstein sees 3% inflation as a plausible new normal after years of 2% inflation, especially given reduced globalization and supply-chain shifts. Rubenstein believes private markets are likely to rebound because recession uncertainty freezes transactions and valuation gaps narrow when the outlook improves.

Data Points: U.S. growth momentum (first half 2023): below 1% - Hatzius’ baseline forecast for near-term U.S. growth U.S. growth momentum (second half 2023): above 1% - Hatzius expects growth to pick up later in the year Official rent inflation: close to 10% annualized - Hatzius cites still-elevated CPI/PCE rent measures Debt-to-GDP ratio: 100% - Cochrane uses this to argue rate hikes materially worsen deficits Extra deficit from a 1 percentage point rate increase: about $250 billion - Cochrane’s estimate of higher interest costs on government debt Fiscal stimulus in the pandemic era: about $5 trillion - Cochrane says this was the main inflationary shock Desired long-run U.S. inflation norm: around 3% - Rubenstein says this is likely acceptable and persistent Typical historical U.S. inflation level: about 3% - Rubenstein references 1950s-60s economics textbooks Inflation target / recent norm: 2% for about 25 years - Rubenstein says this became the expected benchmark after Volcker and globalization Public market performance in 2022: down 20% to 30% - Rubenstein contrasts public market declines with private-market marks Private market marks in 2022: down 5% to 10% (if at all) - Rubenstein says private valuations held up better than public markets Typical private equity outperformance: 200 to 500 basis points - Rubenstein says private equity has outperformed public market indexes on average over decades

Pivotal Quotes: "We have the weakest U.S. growth momentum in the near term, a little bit below 1% in the first half, and then we're a little above 1% in the second half, and then approaching trend growth as we close out 2023." — Jan Hatzius: Hatzius’ baseline outlook for growth "The influence of interest rates on inflation is a lot weaker than most people normally think... The Fed does not have complete control over inflation." — John Cochrane: Cochrane’s core critique of monetary policy "I suspect 3% will probably be the norm for some time." — David Rubenstein: Rubenstein’s view on the likely inflation regime

Implications: For investors, the episode suggests inflation may keep easing even if growth improves, but fiscal risks remain a potential long-term trigger. Private markets could thaw if recession fears fade, while listeners should expect a likely shift from 2% toward a 3% inflation environment.