‘Permanent’ Damage: Why The Economy Changed Forever | Justin Wolfers
Summary
Geopolitical Risk: The Iran conflict is framed as potentially long-lasting, with markets reacting sharply to escalation/de-escalation and wide uncertainty around outcomes.
Defense Spending: The guest expects sustained global increases in military budgets, implying higher U.S. taxes and ongoing support for the Aerospace & Defense complex.
Oil Shock: Elevated oil prices are seen lifting headline inflation but having muted effects on core, shaping a nuanced policy response from the Federal Reserve.
Interest Rates: Debate centers on whether the Fed will still cut this year; markets lean to no cuts as inflation expectations risk keeps policymakers cautious.
Gold: Gold’s surge is discussed as a social-convention safe haven during crises, despite the guest’s skepticism about its intrinsic value.
Bitcoin: Compared to gold, Bitcoin is viewed as another belief-driven asset that could theoretically go to zero, underscoring risk in crypto as a store of value.
Labor and Growth: Payrolls and unemployment trends are called noisy, with weather and population dynamics complicating signals, suggesting modest growth but rising downside risks.
No Stock Picks: No specific tickers were pitched; the focus was on macro exposures in Energy, Aerospace & Defense, and safe-haven assets like Gold.
Transcript
And there's nothing that happened this week that makes me entirely confident that this is a six-w week war rather than something that will be measured in years or decades instead. Speak softly and carry a big stick used to be the way that the United States carried itself in the world. And now it's bellow loudly and carry a wet noodle. Why do we care about a yellow rock? Things only have value if other people think they have value. I only believe these zeros and ones have value if other people believe they have value. The Iran conflict has caused permanent damage to the economy and we're going to find out what this permanent damage is. We're also going to find out how the Fed is going to respond and what's next for economic growth. Will our living standards change materially in 2026 and how? Justin Wolfers joins us now to discuss these topics. He is uh the professor of public policy and economics at the University of Michigan and the host co-host of Think Like an Economist podcast. He has a PhD in economics from Harvard and he is a columnist also for the New York Times. Welcome to the show, Justin. Good to see you. >> Pleasure to be here, David. >> I want to start with a recent post that you made on X on the 7th of April. Let me just share my screen. Uh this is something you said even a quick Iran deal wouldn't won't under uh undo, sorry, won't undo the damage already done. stock losses, years of elevated oil prices, and a $350 billion defense budget increase that quietly translates to $3 to $4,000 in added taxes per household. Nobody likes higher taxes. How are we going to see higher taxes, Justin? >> Well, right, good question. So, uh, let me take it back one step cuz I think you're asking the important question and the deep question, which is if the conflict ends, the two sides hug it out and figure they'll get on with their lives. Um, does that mean we're back to where we were were when we started? And I think the answer is very clearly no. The clearest way to see that is to just think through the implications for defense spending. um realize of course that every dollar we spend on defense is a dollar we don't give us tax cuts is a dollar we don't spend on schools or roads or any of the other good stuff. It's a dollar we spend on bombs. Um the given what the president said he can't unsay that he threatened to end a civilization. Uh that fact remains with us. Um, once a president threatens to end a civilization, I got to figure the next thing the Iranians are going to do is sort of amp up their defense budget. Once you've seen the rest of the Gulf region get bombed, either by Israel, the US, or by Iran, what are they going to do? They're going to amp up their defense budgets. Once you've seen the president threaten to invade Greenland or start an unprovoked trade war with Europe and once the president has showed that the US is an untrustworthy partner first of all in Ukraine and arguably in Iran where he went in without talking to our allies first. What do you think the Europeans are going to do? Do they feel as secure under the American security umbrella as they once did? Probably not. They're going to amp up their defense spending. Then that brings us back to the United States. If most of the other countries around the world are amping up their defense spending and we want to maintain our military superiority, what do we got to do? Amp up our defense spending. >> Well, Justin, just on that note, can an argument be made that if our European allies or other perhaps even Asian allies ramp up their defense spending, the American economy and the taxpayers ultimately don't have to pay as much to protect those allies, meaning our defense budget in the US can be lowered? No. And so that's a really important distinction. So there's two ways we could think about our allies amping up their defense spending. It could be that what the president had proposed early in the term that he wanted others to be doing a better job and he didn't want the US to be the world cop. If that were the case, that's a share the burden approach and if he'd succeeded at that, that would reduce American defense spending and therefore the burden on American taxpayers. This what's happening this time though is not that. It is we are afraid of the US. We are less secure under the American umbrella. We want to have independent military might. Certainly that's going to be the case in the Gulf. Arguably in Europe and Asia, it's a little less clear there. But if we find that those we might go to war with in the future have bigger militaries, that means we need to spend more on defense. And then the question is how much more? And we could look at the president's budget. in the president's budget asks for a $1.5 trillion defense spend, which is $350 billion more. Now, there's a very, very simple fact in the world. If you're going to spend another dollar, that means you're going to have to tax another dollar. So, when the president announces another $350 billion in defense spending, he's also announced another $350 billion tax hike. There's 350 million Americans. So that's roughly speaking $1,000 per American. There's a tax hike right there. And that's true whether we're in peace or war. If we if we're at war, it's probably even larger still. Well, let's come back to uh the war itself. I want to talk about how these conflicts have traditionally or historically impacted the economy and per uh my introduction perhaps led to recessions. Let's take a look at some prior recessions going back to the 80s. 2020 was COVID. 2008 was a financial crisis. 2000 was the tech bubble. 1990 uh it coincided with the first Gulf War. But according to uh the St. Louis Fed data here that I'm showing on my screen, the recession really started in Q4 1989. The Gulf War was middle of 1990. Was there any impact at all from the Gulf War on the economy in terms of recessions and growth? >> Yeah. So, um I'm just going to tell you I'm too young to have strong strong memories of that particular war. Um I'm proud I get to say that. But let's talk about the second Gulf War because that was one I actually did research on. Um I had a research paper that came out during that period was that the early 2000s um uh with Eric Zitzawitz and what which it was a very different war than the current one because the president made the case for going to war very slowly over a period of months. It was the front page story all day every day. Are we going to take Satam out? And it turns out there was a very early prediction market. We have them everywhere now but at the time they were quite rare. There was a prediction market. will the US go to war with Iraq, not Iran? And um that moved up and down as the president's rhetoric changed. And what was astonishing was how closely correlated that was with what was going on with US stocks. And basically in a week in which it became 10% more likely we go to war with Iraq, US stocks on average would fall 1.5%. And so if you were to scale that up, that tells you maybe 1 to one and a half%. So if a 10% change in the chance of war is worth 1 to 1 and a half% on stocks, then a 100% change in the chance of war is worth 10 to 15% on stocks. That exper So that's not saying that's necessarily what the cost was. It's a very difficult thing to to calculate, but that says that markets were acting as if they believed American stocks were worth 10 to 15% less if we went to war in Iraq. Economists have subsequently gone back and um tried to calculate the economic cost of that Iraq war. By some estimates, the cost is to be measured in trillions of dollars. That's enough that those two estimates, the stock market freaking out and the sort of more line by line estimates sort of cohhere. That experience really shapes how I think about what's going on at the current moment because you've seen on days in which escalation is more likely, American stocks have fallen dramatically. We saw when the president just deescalated that American stocks rose very sharply. And so the latest deescalation caused stocks to rise by about 3 percentage points. The latest deescalation didn't take us from 100% chance of war to zero. It was probably from some other number to some other number. But that order of magnitude seems to suggest that, and I'm going to be really rough here, that the Iran war is not expected to be dramatically different in terms of economic consequences than the Iraq war. And if that's the case, you know, it could be 5% instead of 10%, but orders of magnitude here. If that's the case, the economic consequences here again are going to be measured either in trillions or in hundreds of billions of dollars. Um, and they may or may not play out directly in GDP. A lot of these consequences don't play out in next quarter's GDP. So that's why I think focusing on the next recession is a a strong media talking point, but probably economically not the right place to look. 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Scan the QR code on the screen or go to jointdeme.com/david, link in the description down below, and use my code David Linn for 20% off. Take control of your privacy today. Now, back to the video. Well, the Iraq war lasted eight years. If we're talking about how this may not be this that that different, are we also looking at a protracted multi-year conflict with Iran? Is that the assumption here? >> So, no, that's the question. Um, so I want to remind you that on the eve of the Iraq war, Donald Rumsfeld said this war could last 6 days, maybe 6 weeks, but I doubt 6 months. And the point of that quote is that Rumsfeld understated the duration of the war by an order by a factor of 365. In fact, even more than that. And so what that says is when you're looking at these sorts of conflicts, the argument isn't whether it's going to be a four-week war or a six week war. We should more or less learn from Iran Iraq. When we say four weeks, it could be 4 months. It could be four years. And it might even be 40 years. And there's nothing that happened this week that makes me entirely confident that this is a six week war rather than something that will be measured in years or decades instead. Um, and so I think you hit exactly the right point. If we turn around, we hug it out, we high five, we say we're done, let's get back to normal, and we do so in an enduring, sophisticated, clever way that keeps both sides on track, then I think you're right. The the consequ the long-term consequences will be remarkably small. If on the other hand this raises ongoing tensions, changes geopolitical maps, changes defense spending, changes uh the the perceived riskiness of the United States, changes bond yields, changes exchange rates, changes stock market valuations, then the consequences are much larger. And the truth is right now we don't know which of those scenarios we're looking at. Currently, we're off to a rocky start with this two-week ceasefire as Iran accused Israel of violating ceasefire uh conditions by attacking Lebanon. And so, the question is uh how would an economist evaluate how long a ceasefire like this could last, whether it's 2 weeks or it ends after that and we go back to war. What is the framework for making this evaluation? It's a good question. And so this is a point at which um an economist, an honest economist would say at some point we got to bring in the foreign relations guys. >> Yeah. >> Because they study this for a living. Um but okay, here's what I think. Let me answer first as a person. >> Yes. >> As a person, I've got all my fingers and toes crossed and I hope that we figure it out. >> Let me try and give whatever input an economist can. And I think the most useful beyond acknowledging my lack of expertise, let me bring in the one thing I do have some expertise in, which is you and I, David, have just lived through one year of reporting on a trade war. And this war war comes from the same writer room. What did we see through that trade war? We saw the only constancy out of the White House was inconstancy. They would escalate tariffs on China to 130% one week and bring them down to 20% the next. It took them 11 months to realize that tariffs on bananas weren't going to bring banana factories back to the United States. The president uh put higher tariffs, I think it was on the Swiss because he didn't like how the Swiss leader spoke to him. Um these were not the moves of a consistent reliable actor of the form that most of our tools are used to thinking about. Um so one I think the president's n the nature of this presidency makes it very very difficult to forecast but that's actually useful. It still tells you something. What it means is I can't say David this will definitely be over in 3 and 1/2 days. What I can say to you is given what we've seen in the past anyone who says anything with any degree of confidence is is overconfident and the confidence interval here should be very wide. The problem with a wide confidence interval when you're talking about wars is that includes some very very bad outcomes and that's why all my fingers and toes are crossed. >> Well, you also wrote in your tweet that the economy doesn't just snap back. Some of this is permanent. What is permanent, Justin? >> Uh, so I think the most important permanent thing is that the president has said that he's willing to blast an entire civilization off the face of the earth. There's no takebacks on that. Everyone around the world heard it. that changes America's role in the world. Um, we can, you know, it changes our credibility when it first I think that the the first most important thing that that's going to do is it's going to change military spending both abroad and at home. It probably changes our perceived reliability to our NATO partners, which may in turn have even broader implications. But I think it also has other implications. The United States has not looked like a steady trading partner during the trade war and now we're talking about blowing countries off the face of the earth without even talking to um our allies about it. I think there's sort of a sense in which other countries are going to want to seek refuge from the uncertainty and I might even say madness coming from the White House at the moment. And the way you do that is you friend shore or you find ways around the United States. And this is I think it's just part of a broader piece which is the president is taking us down an isolationist route. Maybe that's what he wants but it's very hard to see how isolation from international markets from um international security and even from simple things like the international market for education. Um I teach at a university where a large part of our revenue comes from the fact that I teach kids from all around the world. Parents aren't going to be so happy sending their kids over here anymore. Um, so you can think about many little stories that collectively add up to something pretty big, >> a longer term impact. But that leads to another question, Justin, which is how do investors sift through signal from noise, particularly from the president's remarks, cuz you'll recall he made that tweet or not tweet, but he wrote that on Two, I believe, Monday morning 8:00 8:06 a.m. I remember correctly. Yeah, we're going to wipe out, you know, an entire civilization will die tonight if the deadline is not meet were his words. and he wrote that right before a ceasefire uh deal or negotiation was reached. And in fact, I remember that morning markets didn't take that seriously at all. In fact, it barely budged. So, yes, it was strong language, probably inappropriate language, but ultimately nobody really cared is what I'm trying to say. How do we sift that out from actual actionable rhetoric, >> right? So, two observations to make there. One is that the president's long history of untruths and rhetoric detached from actual action has reduced the power of the president's speech. Um, speak softly and carry a big stick used to be the way that the United States carried itself in the world and now it's bellow loudly and carry a wet noodle. Um, one of those gives us great power in the world, the other does not. And I think the president has actually undermined the presidency's ability to uh shape world affairs. That's a real cost. If we're going to have the world's biggest military, but we can never speak seriously about when and how we're going to use it, then no one's ever going to listen to us, then why the hell did we spend those billions of dollars on the world's greatest military? The second is the second thing I want to turn from sort of thinking about this as an international relations issue and thinking about it instead as a purely financial issue. When the president speaks, sometimes he's telling the truth and sometimes he's not. That's a very difficult signal extraction problem for folks in markets. Yes, he threatened to take Greenland and he didn't take it. Yes, he threatened to annihilate Iran and he didn't do it. But he did also threaten to overthrow Venezuela and did it. Um, so sometimes he does follow through. So therefore, what traders have to do, roughly speaking, is take what the president says with not just a grain of salt, but a hefty bath of salt. Um, wow, bath salts. Didn't think we'd be talking about that today, but um, I hope you have great bath salts. Um, what that in turn means, it's really interesting what that means. It used to be when the market moved one percentage point, it would move one percentage point because the president said something and the market thought that thing that the president said would reduce the value of stocks by one percentage point. Now when the market moves one percentage point, if the president think that if if the market thinks there's only a one in4 chance the bloke's serious, that means that when it thinks reality would cause that the action would cause stocks to fall by one percent by four percentage points, it'll fall by one percentage point. So that in turn means that when we see modest movements in markets that SILS is incredibly consistent with them saying if the president were to follow through the economic implications would be enormous. I have no idea if I was clear just then. David. >> Yeah I I understand what you're saying. It's it's very difficult to actually take the president's uh words uh at face value and actually apply a trading signal to that. Uh but let's take a look at economic data. Can we actually use economic data as a signal? March payrolls, for example, came in at 178,000, well above the consensus estimate of 59,000. Uh the 3-month average still sits just at 68,000 after February was revised down to a negative 133,000. So these payroll numbers have become noisier and noisier in recent months compared to prior years. How do we use labor market data as a gauge of economic growth? Um, it's so we can all complain about the data we have and then I just want to remind you that these are the least imperfect numbers we have. I'd much rather take the pulse of the economy using non-farm payrolls than using retail sales or um the ISM numbers or anything like that. >> Um the let me say two more things. Um the numbers were really positive and anyone who doesn't update as a result of that becomes somewhat more optimistic. I think you're not paying attention. Now these are all pre-war numbers. Um the second thing I'd say about it is there's a very interesting series put out by the San Francisco Federal Reserve where the numbers that the administration puts that the statistitians put out as seasonally adjusted. So they say what typically happens in March, but they're not weather adjusted. But we know weather has a really big effect on things like construction, employment, and so on. And it turns out if you apply a weather adjustment, the San Franc the San Francisco Fed reckons that in fact we lost tens of thousands of jobs in March as we did the previous month. I wouldn't bet my house on that being exactly accurate, but what that does is it makes me wonder, is this a false signal? And I think there's a reasonable chance that it is. I think I said I'd only say two things. I want to just say one more thing here. Um there's one more thing that makes interpreting payrolls very very difficult right now, which is the United States has moved from decades of positive population growth to with the immigration crackdown, population growth being very close to zero and possibly negative. That in turn changes the equation for how many jobs do we need to create in order for us to be treading water. But the problem is no one quite knows what that estimate is. I've seen estimates as low as zero and as high as 70,000. And so while that's unclear, while it's unclear what's happening to population growth, we may be better off focusing on the unemployment rate because the unemployment rate really is a measure of how many jobs are we creating relative to how many do we need to create. And on that measure, it's sort of going sideways, very, very slowly, drifting up. It's kind of hard to tell, but it looks like things aren't terrible, at least. >> Yeah, you tweeted about this actually. The unemployment rate, uh, the trend is going up. It's still what is the historical average above which you would be concerned as an economist, Justin? >> Yeah. Um, so, right, so it's a really good question, David. um because I was talking about the change and you were focusing our attention on the level and they're both very they're both important objects for very different reasons. So right >> um the level of unemployment really is how well are we doing now the good news is it was down as low as 3 and a half% a couple of years ago. The bad news is it's back up to 4 and a quarter. So the rate of change is in the wrong direction now. Uh historically we would have said you know if it's four and a quarter that's really pretty good. Um there's a so the let's put both things in the same sentence then we say the unemployment rate tells us the labor market is in a moderately good position but moving in the wrong direction albeit very very slowly. And then we're going to add one more complication which is I think the simplest answer to your question would be over the long run unemployment has been round about 5%. So some people would say that's the natural rate and anything below five is terrific and we should be really happy. And the problem with that story is that over the long run the average rate actually tends to change. And the real magic of getting an economy right is actually reducing that average rate. and there was reason to be somewhat optimistic that the US economy can do better than 5% unemployment. Um, and I still retain some of that optimism. >> You'll recall that in 2022 there were two quarters of consecutive negative GDP growth. It was not officially declared a recession, but by some textbook measures that was technically a recession, although not officially declared one as such. How do you explain two quarters of negative GD pro GDP growth at a year at a time while the unemployment rate was falling as per this graph? >> Yeah, good question. So, look, first of all, I I you might want to take a look at this. My memory is that one of those negative quarters got revised back to being positive um back in 2022. >> Okay. >> Uh that me my memor is also imperfect. Um but the question still remains which was GDP growth was very weak even as unemployment was falling. Um look there's a lot going on there. One the way we make our GDP sausage is actually remarkably uglier than almost anyone wants to admit and I think using GDP as your primary indicator of the state of the economy is probably not the best way forward. Um if we could measure it perfectly it might well be but we don't. Um the second is back in 2022 there was still a lot of very interesting and important post-pandemic dynamics going on. You know people had gone home, people were out of the labor force where people returning. Um you know we basically unplugged the machine and turned it and plugged it back in and and that's a good way of fixing windows but it's not necessarily a healthy thing to do to an economy. So um mate I don't have a complete story of 2022 but 2022 was a very odd little mystery actually. >> Okay. Yeah, that is odd. And where I'm going with this is how the Fed reacts to data. This is we need to talk about this. The Fed minutes came out yesterday. Uh we're speaking on Thursday the 9th today. Fed minutes show growing openness to rate hikes at March meeting. >> Yeah. >> Uh a growing number of uh Federal Reserve policy makers felt last month that interest rate hikes might be needed to counter inflation that continued to exceed the central bank's 2% target, particularly given the inflationary impact of the US-Israeli war with Iran. um maybe comment on how the Fed makes decisions. You you know it's my understanding that they look at core PCE data which excludes food and energy. So one has to wonder how higher oil impacts Fed policy. >> So on Friday the latest CPI numbers come out. >> Yeah. >> And they're going to show the effects of the Iran war and they're going to show headline inflation going spiking in a quite dramatic way. Uh now the flip side of that is economists have always said don't pay too much attention to headline inflation. Headline inflation is what it is. It measures what it's meant to measure which is what's happening to the cost of living. Policy makers though should be thinking about what is the underlying inflationary momentum in the economy. And it turns out there are a few goods whose ups and downs don't say a lot about the underlying inflationary momentum in the economy. One of those is food. Why is that? uh things like droughts affect food prices and they don't affect underlying inflationary psychology and the other is actually oil uh energy and the reason for that is that we see things all the time go on in the Middle East that don't have much to do with underlying momentum in the American economy and so if we want to figure out what the underlying pace of inflation is that we can expect to continue over the next few years the real signal there comes from core inflation it excludes food and energy most of the serious economic models suggest that the oil price shock coming out of Iran will have quite a large effect on headline inflation but actually very very muted effect on core inflation. If the Fed were to take this view seriously that core inflation is not going to move very much and that unemployment's probably rising at a very slow rate that would suggest maybe the Fed ought to be somewhat doubbish. It ought to be thinking about lowering interest rates. I that's a view I take very seriously because I take our economic models and understanding of the economy very seriously. >> Well, right. >> Sorry, please. >> There's the the counterargument of the Fed, I can just explain the case and I think it's also a serious one is inflation expectations beget inflation. If everyone expects the cost of their inputs to rise by 4% and they expect their rivals to raise their prices by 4%, they think to themselves, I think I just got to raise my prices by 4% just to keep up. The concern at the Fed is higher gas prices, higher oil prices, higher fertilizer prices. Remember gas prices, it's the only price in the economy that literally is shown at 6 feet tall. Um, and the fear is this really shapes inflationary psychology. And the second fear is that the Fed has had inflation above its target now for 4 and a half years. And if we keep having inflation above its target, maybe an inflationary psychology will take hold where people begin to expect higher inflation and that causes higher inflation. And the Fed is desperately keen to tamp that down. So in this alternative story, what the Fed's worried about is not oil prices, but actually inflation expectations. And if it can keep a lid on inflation expectations, that's when it will feel comfortable to cut rates. >> Right now, the markets don't believe the Fed will raise rates. This is the CME Fed Wash tool. Um, so it's using bond market data to make a prediction. As of April, uh, sorry, as of today, April 9th. Uh, the expectation at the April 29th meeting is that the Fed funds rate will stay unchanged. And this expectation actually lasts throughout the year. um you don't actually get a meaningful percentage uh at either a 25 basis point cut or hike um at all until December 2026. Now, let's just say for the sake of argument the market's wrong, the Fed at some point raises rates this year, not lowers, raises rates. What happens if the Fed raises rates this year, Justin? What would happen to the economy? >> Okay, so actually, let me come back and set the stage a little more there. So you're you're exactly right to say what had happened. If you talked to me on February 27 before the Iran war, the market and the Fed basically all agreed there'd be some rate cuts coming this year roughly probably round about two. The Iran war happened two to three maybe. The Iran war happens there's this big spike in inflation in sorry in headline inflation which will come will be shown in the latest CPI numbers. Um, and the Fed relying on the sorts of economic theories I just described to you in response to your past question said, "Well, you know, that slows us down a little, but we still expect to cut rates." And according to the most recent Fed meeting, they still anticipated one to two rate cuts with a little bit more weight on one rate cut rather than two. Whereas markets move to saying there's no more rate cuts coming this year at all. So most of the debate is will the Fed stick with its expectation that it's going to look through some of the oil shock and still cut rates a little bit later in the year versus we don't believe they're going to do that they're going to be so embarrassed by these high inflation numbers they're going to feel that they have to raise rates. That's where most of the debate has been so far. You've just pushed us David to and I think by the way as a matter of history usually when the Fed says something if it says it in a careful and thoughtful way and the market believes something else I tend to believe the Fed. This is a case though where Jerome Powell I think was very clear at the last meeting. He said we really haven't done a lot of work factoring in the latest war. There was just no point like you may as well just wait and find out what happens and update your views after that. So this is a case where I think the Fed has shown a real willingness to be responsive to whatever changes are going to happen. So this could be a round that the markets win, in which case we end up with no Fed rate cuts this year rather than the one or two that they're currently pointing to. >> So let's take what the markets think. What happens if there's no cuts this year? What will happen to the economy? >> Right? So economic growth is a little bit slower relative to the counterfactual in which there had been. um >> in a world in which and you know how worried you are about that depends a lot on how you think we're currently doing. So if you think we're sort of doing okay right now and interest rates stay sort of like they are okay right now then you'd feel kind of comfortable about that. If you're on edge and you think that the economy is on the precipice of a recession and it needs some help to get us out of that and then this would really worry you. Um, and this comes back to the earlier question you're asking about how do you see what's going on with the labor market right now? Um, if you believe the labor market is showing um the latest if you believe the strength from the latest number then you'd say, "Oh, we're doing okay. We're fine without an extra rate cut." If you believe the San Francisco Fed that that okay is a weatherinduced illusion and we've been losing job we continue to lose jobs at a rate that we haven't seen in years then you're worried that the Fed's not ready to act to try and help us out right now. >> I think ultimately the average American and anybody in the world wants to know what are the economic conditions necessary for real wages to rise meaningfully. meaning my standard of living is going to beat inflation because my salary or wages will rise faster than the rate of change of the goods that I consume. Are we in that condition today? >> Not really. Um >> and we're not because of two reasons. Um one is tariffs and the other is the oil shock. So let me just briefly explain why that really makes a difference. So historically, your real wage, your spending power, that's what we care about, right? Um the idea that that is determined by the level of inflation doesn't really make sense when you think about it. Um now it might be for a little while, which is if prices go up rapidly, it takes a while to convince your boss that you need a pay rise. But we also know from looking at dozens of countries from dozens of decades, typically when prices rise, wages rise to keep up. takes a little while, but it happens pretty quick. And so therefore, your spending power is not determined by inflation. So, a lot of people right now don't feel that in their bones, but that's because they've grown up, David, you're, I'm guessing, younger than me. You've grown up where for most of your life, inflation's been really low. Those who are a little older than you, your parents' generation grew up, they experienced very high inflation through the 1980s, and they understood the deal. When prices rise, wages rise to catch up. Now there's something different though about a tariff induced inflation. So the thing is what normally would happen is if prices rise then the widgets that I produce my boss can sell them at a higher price. That means that the value in dollars that I produce for my boss are higher. My boss therefore wants to give me a pay rise in order to make sure I stick around. But when prices rise because your costs rise, say because of tariffs or an oil price hike, the boss no longer has more money left. The boss has no reason to give me a pay rise. And so a supply shock induced price hike is the one kind that's not going to lead to a corresponding wage hike. So in fact, it's much more painful. It actually leads it's it prices are going to rise without necessarily guaranteeing people's wages are going to catch up. >> We know that prices are sticky upwards, meaning when they go up, they usually stay high. But during a recession, we have deflationary forces. Do you see anything or any particular sector that has a higher chance of going down in price this year? I'll give you a personal anecdote and the one thing I have in mind is rent. Where I live in Vancouver, people are negotiating with their landlords to actually keep their rent st uh stable or mark down their rents. I actually know somebody who is a landlord who had to mark down his rent for the first time ever in his life. That's one example. Do you see anything else? >> Yes, but I want to start by drawing a very sharp distinction. So when economists talk about inflation, we mean a generalized rise in prices. >> Yes. >> Across all prices. When economists talk about deflation, we meant a generalized fall in prices across everything. What you're describing is instead a change in the price of one good relative to others. Um, and in your case, you're talking about Canadian real estate and Canadian rent and the Canadian rents might be falling. I believe some of that's also happening in the United States. When economists talk about the cost of deflation though, we're talking about the costs of a generalized fall in the cost of living, which is not what you're describing. Um, at any given point in time, there's actually lots of goods whose prices are falling. So, uh, you you talked about rent. Uh, my favorite one is the price of AI services. So, I code a lot. I make API calls to open AI and anthropic. The price of using those models like it halves every 3 or 4 months. It's a dramatic decline in prices. That's a specific example. But what we find generally is that technology products tend to fall in price over time, right? TVs just get cheaper and cheaper or they get better and better. Laptop computers are exactly the same. Phones exactly the same. Um, that doesn't upset the Apple card. Um, it might mean that you don't want to buy this year's model of PC or the latest iPhone because you hope you'll get it cheaper or you'll get a better one in a year or two's time, but the macroeconomic implications of that are pretty minor. >> Well, let's close off on your work. So, I mentioned in the beginning of the interview, you co-host a podcast with Bezie Stevenson, whom I've had the pleasure of interviewing actually on my show as well. Uh, Think Like an Economist is the name, and you're also starting a new show. What are some of the topics you'd be focusing on? Give us a teaser. >> So, that earlier podcast was really an audio course, which is if you want to learn economics and you can't be in my economics 101 course, go and take Think Like an Economist. Uh this David, honestly, I admire what you're doing with your audience, which is I believe the world would be a better place if we knew more economics. And it turns out that the university pays me to teach the to teach economics. And so what I want to do is is bring the superpower that is economics to people. Um I probably won't, you know, to some degree I'll follow the ups and downs of what's happening day by day, but I also think I may have bored some of your listeners right now. You might have noticed I have a tendency to teach rather than to talk. Um, and I think that when people understand what's going on in the world around them, the anxieties many of us feel right now actually fall. So, I think economics is a superpower. And I just want to teach people to learn how to fly. >> Well, I'm curious how how you would answer this final question I have for you. Uh, you teach economics to uh students every year uh at an entry level, you said. So, how would you explain to, let's say, a freshman in college how or why gold is trading at nearly $5,000 an ounce and has doubled in just a span of less than 18 months? >> Oh, wow. So, great question because the answer is I would tell them gold confuses the living crap out of me. And I don't know if we're allowed to swear, but um so let me answer a slightly different question, but I think they're related. >> Sure. >> Some students come to me and they say, "What's going on with Bitcoin? Should I invest in Bitcoin?" I'm like, Bitcoin is zeros and ones. It has no inherent value. I would never buy it. I believe there's a big chance one day the value of Bitcoin goes to zero. Now, this is where I want to show a moment of humility. This is where we come back to gold. Gold has no inherent value. It's a shiny rock. Like diamonds actually have industrial value, right? Where you can make drills and things like that out of them. Gold is just a shiny rock. It doesn't do much. Why would I want to pay anything per ounce for gold? Um, and it turns out people buy gold because they think other people value gold. And that's a self-sustaining equilibrium. The same thing is true of Bitcoin. So, look, if you told me the value of gold were to fall 97% tomorrow, I wouldn't be surprised. Uh, it would be that we all just stop believing that yellow metal is more important than yellow rocks are. At the moment, we seem to believe yellow rocks are more important than rocks of other colors. That's a social convention. That social convention could go away. >> But the narrative that gold is a counterdoll asset, I don't know if you agree with that first of all, but let's say you do. Does the price of gold rising the way it has signal to you that the dollar has lost or is about to lose purchasing power? >> Right. So, I sort of answered a different question than the one you're asking, which is this deep fundamental question like why do we care about a yellow rock? >> Yeah. And I said it's because of a social convention. Let's bring the two closer together, which is the social convention is >> it's a yellow rock that we all think will continue to be valuable in the future even if other assets aren't. >> That's why you might call it a safe asset. Now again, I just want to point out that's a social convention. So if I thought that my civilization was about to be blown off the face of the earth and the only thing that will persist are yellow rocks and the social convention that yellow rocks are better than other colored rocks, then I would want to buy a lot of yellow rocks. That's probably sort of a metaphor for what's happening right now. And if you want to sharpen the edges of that, I'm just going to say, David, you're probably better qualified than I am to answer that. I I I'm just wondering if the social convention is going to shift towards another currency that's not the dollar or a yellow metal in the future. Perhaps another fiat currency or perhaps a digital currency. And we'll close off here. >> Absolutely. I look, these are literally social conventions. This is things only have value if other people think they have value. Lots of people talk about the value of Bitcoin being that it's different than fiat money, but again, it's just I only believe these zeros and ones have value if other people believe they have value. >> Sure. >> Same fundamental problem, but money has existed now for thousands of years. It's a it's an amazing thing. And I've also been wrong about lots of things as well. >> Justin, thank you so much. Tell us where we can find your channel, your work, and when we can expect your new YouTube channel to to launch. Yeah. So, shh, it's a secret. Soft launch is underway right now. Um, so if you go to YouTube and look at Justin Wolver, if I haven't put you to sleep already at this point, Dave, it's far more interesting podcast and you feel like you want to learn a little bit of economics, uh, with an Aussie accent. Um, so I'm at Justin Wolfers on YouTube. I'd love to see you over there. Otherwise, I'm available on all the socials and we'll posting clips and all of that stuff. Um, but I'm excited to be I'm I'm excited, David, that we can enlarge this conversation and together maybe we'll teach the world economics. >> It's a remarkable world we live in. Two people on different sides of the world having a conversation and hopefully thousands of people will listen to us talk about economics. So, thank you for your work and contribution to social media. Justin, we look forward to following you on YouTube. >> Thanks, man. >> Thank you for watching. Don't forget to like and subscribe.
‘Permanent’ Damage: Why The Economy Changed Forever | Justin Wolfers
Summary
Transcript
And there's nothing that happened this week that makes me entirely confident that this is a six-w week war rather than something that will be measured in years or decades instead. Speak softly and carry a big stick used to be the way that the United States carried itself in the world. And now it's bellow loudly and carry a wet noodle. Why do we care about a yellow rock? Things only have value if other people think they have value. I only believe these zeros and ones have value if other people believe they have value. The Iran conflict has caused permanent damage to the economy and we're going to find out what this permanent damage is. We're also going to find out how the Fed is going to respond and what's next for economic growth. Will our living standards change materially in 2026 and how? Justin Wolfers joins us now to discuss these topics. He is uh the professor of public policy and economics at the University of Michigan and the host co-host of Think Like an Economist podcast. He has a PhD in economics from Harvard and he is a columnist also for the New York Times. Welcome to the show, Justin. Good to see you. >> Pleasure to be here, David. >> I want to start with a recent post that you made on X on the 7th of April. Let me just share my screen. Uh this is something you said even a quick Iran deal wouldn't won't under uh undo, sorry, won't undo the damage already done. stock losses, years of elevated oil prices, and a $350 billion defense budget increase that quietly translates to $3 to $4,000 in added taxes per household. Nobody likes higher taxes. How are we going to see higher taxes, Justin? >> Well, right, good question. So, uh, let me take it back one step cuz I think you're asking the important question and the deep question, which is if the conflict ends, the two sides hug it out and figure they'll get on with their lives. Um, does that mean we're back to where we were were when we started? And I think the answer is very clearly no. The clearest way to see that is to just think through the implications for defense spending. um realize of course that every dollar we spend on defense is a dollar we don't give us tax cuts is a dollar we don't spend on schools or roads or any of the other good stuff. It's a dollar we spend on bombs. Um the given what the president said he can't unsay that he threatened to end a civilization. Uh that fact remains with us. Um, once a president threatens to end a civilization, I got to figure the next thing the Iranians are going to do is sort of amp up their defense budget. Once you've seen the rest of the Gulf region get bombed, either by Israel, the US, or by Iran, what are they going to do? They're going to amp up their defense budgets. Once you've seen the president threaten to invade Greenland or start an unprovoked trade war with Europe and once the president has showed that the US is an untrustworthy partner first of all in Ukraine and arguably in Iran where he went in without talking to our allies first. What do you think the Europeans are going to do? Do they feel as secure under the American security umbrella as they once did? Probably not. They're going to amp up their defense spending. Then that brings us back to the United States. If most of the other countries around the world are amping up their defense spending and we want to maintain our military superiority, what do we got to do? Amp up our defense spending. >> Well, Justin, just on that note, can an argument be made that if our European allies or other perhaps even Asian allies ramp up their defense spending, the American economy and the taxpayers ultimately don't have to pay as much to protect those allies, meaning our defense budget in the US can be lowered? No. And so that's a really important distinction. So there's two ways we could think about our allies amping up their defense spending. It could be that what the president had proposed early in the term that he wanted others to be doing a better job and he didn't want the US to be the world cop. If that were the case, that's a share the burden approach and if he'd succeeded at that, that would reduce American defense spending and therefore the burden on American taxpayers. This what's happening this time though is not that. It is we are afraid of the US. We are less secure under the American umbrella. We want to have independent military might. Certainly that's going to be the case in the Gulf. Arguably in Europe and Asia, it's a little less clear there. But if we find that those we might go to war with in the future have bigger militaries, that means we need to spend more on defense. And then the question is how much more? And we could look at the president's budget. in the president's budget asks for a $1.5 trillion defense spend, which is $350 billion more. Now, there's a very, very simple fact in the world. If you're going to spend another dollar, that means you're going to have to tax another dollar. So, when the president announces another $350 billion in defense spending, he's also announced another $350 billion tax hike. There's 350 million Americans. So that's roughly speaking $1,000 per American. There's a tax hike right there. And that's true whether we're in peace or war. If we if we're at war, it's probably even larger still. Well, let's come back to uh the war itself. I want to talk about how these conflicts have traditionally or historically impacted the economy and per uh my introduction perhaps led to recessions. Let's take a look at some prior recessions going back to the 80s. 2020 was COVID. 2008 was a financial crisis. 2000 was the tech bubble. 1990 uh it coincided with the first Gulf War. But according to uh the St. Louis Fed data here that I'm showing on my screen, the recession really started in Q4 1989. The Gulf War was middle of 1990. Was there any impact at all from the Gulf War on the economy in terms of recessions and growth? >> Yeah. So, um I'm just going to tell you I'm too young to have strong strong memories of that particular war. Um I'm proud I get to say that. But let's talk about the second Gulf War because that was one I actually did research on. Um I had a research paper that came out during that period was that the early 2000s um uh with Eric Zitzawitz and what which it was a very different war than the current one because the president made the case for going to war very slowly over a period of months. It was the front page story all day every day. Are we going to take Satam out? And it turns out there was a very early prediction market. We have them everywhere now but at the time they were quite rare. There was a prediction market. will the US go to war with Iraq, not Iran? And um that moved up and down as the president's rhetoric changed. And what was astonishing was how closely correlated that was with what was going on with US stocks. And basically in a week in which it became 10% more likely we go to war with Iraq, US stocks on average would fall 1.5%. And so if you were to scale that up, that tells you maybe 1 to one and a half%. So if a 10% change in the chance of war is worth 1 to 1 and a half% on stocks, then a 100% change in the chance of war is worth 10 to 15% on stocks. That exper So that's not saying that's necessarily what the cost was. It's a very difficult thing to to calculate, but that says that markets were acting as if they believed American stocks were worth 10 to 15% less if we went to war in Iraq. Economists have subsequently gone back and um tried to calculate the economic cost of that Iraq war. By some estimates, the cost is to be measured in trillions of dollars. That's enough that those two estimates, the stock market freaking out and the sort of more line by line estimates sort of cohhere. That experience really shapes how I think about what's going on at the current moment because you've seen on days in which escalation is more likely, American stocks have fallen dramatically. We saw when the president just deescalated that American stocks rose very sharply. And so the latest deescalation caused stocks to rise by about 3 percentage points. The latest deescalation didn't take us from 100% chance of war to zero. It was probably from some other number to some other number. But that order of magnitude seems to suggest that, and I'm going to be really rough here, that the Iran war is not expected to be dramatically different in terms of economic consequences than the Iraq war. And if that's the case, you know, it could be 5% instead of 10%, but orders of magnitude here. If that's the case, the economic consequences here again are going to be measured either in trillions or in hundreds of billions of dollars. Um, and they may or may not play out directly in GDP. A lot of these consequences don't play out in next quarter's GDP. So that's why I think focusing on the next recession is a a strong media talking point, but probably economically not the right place to look. 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Scan the QR code on the screen or go to jointdeme.com/david, link in the description down below, and use my code David Linn for 20% off. Take control of your privacy today. Now, back to the video. Well, the Iraq war lasted eight years. If we're talking about how this may not be this that that different, are we also looking at a protracted multi-year conflict with Iran? Is that the assumption here? >> So, no, that's the question. Um, so I want to remind you that on the eve of the Iraq war, Donald Rumsfeld said this war could last 6 days, maybe 6 weeks, but I doubt 6 months. And the point of that quote is that Rumsfeld understated the duration of the war by an order by a factor of 365. In fact, even more than that. And so what that says is when you're looking at these sorts of conflicts, the argument isn't whether it's going to be a four-week war or a six week war. We should more or less learn from Iran Iraq. When we say four weeks, it could be 4 months. It could be four years. And it might even be 40 years. And there's nothing that happened this week that makes me entirely confident that this is a six week war rather than something that will be measured in years or decades instead. Um, and so I think you hit exactly the right point. If we turn around, we hug it out, we high five, we say we're done, let's get back to normal, and we do so in an enduring, sophisticated, clever way that keeps both sides on track, then I think you're right. The the consequ the long-term consequences will be remarkably small. If on the other hand this raises ongoing tensions, changes geopolitical maps, changes defense spending, changes uh the the perceived riskiness of the United States, changes bond yields, changes exchange rates, changes stock market valuations, then the consequences are much larger. And the truth is right now we don't know which of those scenarios we're looking at. Currently, we're off to a rocky start with this two-week ceasefire as Iran accused Israel of violating ceasefire uh conditions by attacking Lebanon. And so, the question is uh how would an economist evaluate how long a ceasefire like this could last, whether it's 2 weeks or it ends after that and we go back to war. What is the framework for making this evaluation? It's a good question. And so this is a point at which um an economist, an honest economist would say at some point we got to bring in the foreign relations guys. >> Yeah. >> Because they study this for a living. Um but okay, here's what I think. Let me answer first as a person. >> Yes. >> As a person, I've got all my fingers and toes crossed and I hope that we figure it out. >> Let me try and give whatever input an economist can. And I think the most useful beyond acknowledging my lack of expertise, let me bring in the one thing I do have some expertise in, which is you and I, David, have just lived through one year of reporting on a trade war. And this war war comes from the same writer room. What did we see through that trade war? We saw the only constancy out of the White House was inconstancy. They would escalate tariffs on China to 130% one week and bring them down to 20% the next. It took them 11 months to realize that tariffs on bananas weren't going to bring banana factories back to the United States. The president uh put higher tariffs, I think it was on the Swiss because he didn't like how the Swiss leader spoke to him. Um these were not the moves of a consistent reliable actor of the form that most of our tools are used to thinking about. Um so one I think the president's n the nature of this presidency makes it very very difficult to forecast but that's actually useful. It still tells you something. What it means is I can't say David this will definitely be over in 3 and 1/2 days. What I can say to you is given what we've seen in the past anyone who says anything with any degree of confidence is is overconfident and the confidence interval here should be very wide. The problem with a wide confidence interval when you're talking about wars is that includes some very very bad outcomes and that's why all my fingers and toes are crossed. >> Well, you also wrote in your tweet that the economy doesn't just snap back. Some of this is permanent. What is permanent, Justin? >> Uh, so I think the most important permanent thing is that the president has said that he's willing to blast an entire civilization off the face of the earth. There's no takebacks on that. Everyone around the world heard it. that changes America's role in the world. Um, we can, you know, it changes our credibility when it first I think that the the first most important thing that that's going to do is it's going to change military spending both abroad and at home. It probably changes our perceived reliability to our NATO partners, which may in turn have even broader implications. But I think it also has other implications. The United States has not looked like a steady trading partner during the trade war and now we're talking about blowing countries off the face of the earth without even talking to um our allies about it. I think there's sort of a sense in which other countries are going to want to seek refuge from the uncertainty and I might even say madness coming from the White House at the moment. And the way you do that is you friend shore or you find ways around the United States. And this is I think it's just part of a broader piece which is the president is taking us down an isolationist route. Maybe that's what he wants but it's very hard to see how isolation from international markets from um international security and even from simple things like the international market for education. Um I teach at a university where a large part of our revenue comes from the fact that I teach kids from all around the world. Parents aren't going to be so happy sending their kids over here anymore. Um, so you can think about many little stories that collectively add up to something pretty big, >> a longer term impact. But that leads to another question, Justin, which is how do investors sift through signal from noise, particularly from the president's remarks, cuz you'll recall he made that tweet or not tweet, but he wrote that on Two, I believe, Monday morning 8:00 8:06 a.m. I remember correctly. Yeah, we're going to wipe out, you know, an entire civilization will die tonight if the deadline is not meet were his words. and he wrote that right before a ceasefire uh deal or negotiation was reached. And in fact, I remember that morning markets didn't take that seriously at all. In fact, it barely budged. So, yes, it was strong language, probably inappropriate language, but ultimately nobody really cared is what I'm trying to say. How do we sift that out from actual actionable rhetoric, >> right? So, two observations to make there. One is that the president's long history of untruths and rhetoric detached from actual action has reduced the power of the president's speech. Um, speak softly and carry a big stick used to be the way that the United States carried itself in the world and now it's bellow loudly and carry a wet noodle. Um, one of those gives us great power in the world, the other does not. And I think the president has actually undermined the presidency's ability to uh shape world affairs. That's a real cost. If we're going to have the world's biggest military, but we can never speak seriously about when and how we're going to use it, then no one's ever going to listen to us, then why the hell did we spend those billions of dollars on the world's greatest military? The second is the second thing I want to turn from sort of thinking about this as an international relations issue and thinking about it instead as a purely financial issue. When the president speaks, sometimes he's telling the truth and sometimes he's not. That's a very difficult signal extraction problem for folks in markets. Yes, he threatened to take Greenland and he didn't take it. Yes, he threatened to annihilate Iran and he didn't do it. But he did also threaten to overthrow Venezuela and did it. Um, so sometimes he does follow through. So therefore, what traders have to do, roughly speaking, is take what the president says with not just a grain of salt, but a hefty bath of salt. Um, wow, bath salts. Didn't think we'd be talking about that today, but um, I hope you have great bath salts. Um, what that in turn means, it's really interesting what that means. It used to be when the market moved one percentage point, it would move one percentage point because the president said something and the market thought that thing that the president said would reduce the value of stocks by one percentage point. Now when the market moves one percentage point, if the president think that if if the market thinks there's only a one in4 chance the bloke's serious, that means that when it thinks reality would cause that the action would cause stocks to fall by one percent by four percentage points, it'll fall by one percentage point. So that in turn means that when we see modest movements in markets that SILS is incredibly consistent with them saying if the president were to follow through the economic implications would be enormous. I have no idea if I was clear just then. David. >> Yeah I I understand what you're saying. It's it's very difficult to actually take the president's uh words uh at face value and actually apply a trading signal to that. Uh but let's take a look at economic data. Can we actually use economic data as a signal? March payrolls, for example, came in at 178,000, well above the consensus estimate of 59,000. Uh the 3-month average still sits just at 68,000 after February was revised down to a negative 133,000. So these payroll numbers have become noisier and noisier in recent months compared to prior years. How do we use labor market data as a gauge of economic growth? Um, it's so we can all complain about the data we have and then I just want to remind you that these are the least imperfect numbers we have. I'd much rather take the pulse of the economy using non-farm payrolls than using retail sales or um the ISM numbers or anything like that. >> Um the let me say two more things. Um the numbers were really positive and anyone who doesn't update as a result of that becomes somewhat more optimistic. I think you're not paying attention. Now these are all pre-war numbers. Um the second thing I'd say about it is there's a very interesting series put out by the San Francisco Federal Reserve where the numbers that the administration puts that the statistitians put out as seasonally adjusted. So they say what typically happens in March, but they're not weather adjusted. But we know weather has a really big effect on things like construction, employment, and so on. And it turns out if you apply a weather adjustment, the San Franc the San Francisco Fed reckons that in fact we lost tens of thousands of jobs in March as we did the previous month. I wouldn't bet my house on that being exactly accurate, but what that does is it makes me wonder, is this a false signal? And I think there's a reasonable chance that it is. I think I said I'd only say two things. I want to just say one more thing here. Um there's one more thing that makes interpreting payrolls very very difficult right now, which is the United States has moved from decades of positive population growth to with the immigration crackdown, population growth being very close to zero and possibly negative. That in turn changes the equation for how many jobs do we need to create in order for us to be treading water. But the problem is no one quite knows what that estimate is. I've seen estimates as low as zero and as high as 70,000. And so while that's unclear, while it's unclear what's happening to population growth, we may be better off focusing on the unemployment rate because the unemployment rate really is a measure of how many jobs are we creating relative to how many do we need to create. And on that measure, it's sort of going sideways, very, very slowly, drifting up. It's kind of hard to tell, but it looks like things aren't terrible, at least. >> Yeah, you tweeted about this actually. The unemployment rate, uh, the trend is going up. It's still what is the historical average above which you would be concerned as an economist, Justin? >> Yeah. Um, so, right, so it's a really good question, David. um because I was talking about the change and you were focusing our attention on the level and they're both very they're both important objects for very different reasons. So right >> um the level of unemployment really is how well are we doing now the good news is it was down as low as 3 and a half% a couple of years ago. The bad news is it's back up to 4 and a quarter. So the rate of change is in the wrong direction now. Uh historically we would have said you know if it's four and a quarter that's really pretty good. Um there's a so the let's put both things in the same sentence then we say the unemployment rate tells us the labor market is in a moderately good position but moving in the wrong direction albeit very very slowly. And then we're going to add one more complication which is I think the simplest answer to your question would be over the long run unemployment has been round about 5%. So some people would say that's the natural rate and anything below five is terrific and we should be really happy. And the problem with that story is that over the long run the average rate actually tends to change. And the real magic of getting an economy right is actually reducing that average rate. and there was reason to be somewhat optimistic that the US economy can do better than 5% unemployment. Um, and I still retain some of that optimism. >> You'll recall that in 2022 there were two quarters of consecutive negative GDP growth. It was not officially declared a recession, but by some textbook measures that was technically a recession, although not officially declared one as such. How do you explain two quarters of negative GD pro GDP growth at a year at a time while the unemployment rate was falling as per this graph? >> Yeah, good question. So, look, first of all, I I you might want to take a look at this. My memory is that one of those negative quarters got revised back to being positive um back in 2022. >> Okay. >> Uh that me my memor is also imperfect. Um but the question still remains which was GDP growth was very weak even as unemployment was falling. Um look there's a lot going on there. One the way we make our GDP sausage is actually remarkably uglier than almost anyone wants to admit and I think using GDP as your primary indicator of the state of the economy is probably not the best way forward. Um if we could measure it perfectly it might well be but we don't. Um the second is back in 2022 there was still a lot of very interesting and important post-pandemic dynamics going on. You know people had gone home, people were out of the labor force where people returning. Um you know we basically unplugged the machine and turned it and plugged it back in and and that's a good way of fixing windows but it's not necessarily a healthy thing to do to an economy. So um mate I don't have a complete story of 2022 but 2022 was a very odd little mystery actually. >> Okay. Yeah, that is odd. And where I'm going with this is how the Fed reacts to data. This is we need to talk about this. The Fed minutes came out yesterday. Uh we're speaking on Thursday the 9th today. Fed minutes show growing openness to rate hikes at March meeting. >> Yeah. >> Uh a growing number of uh Federal Reserve policy makers felt last month that interest rate hikes might be needed to counter inflation that continued to exceed the central bank's 2% target, particularly given the inflationary impact of the US-Israeli war with Iran. um maybe comment on how the Fed makes decisions. You you know it's my understanding that they look at core PCE data which excludes food and energy. So one has to wonder how higher oil impacts Fed policy. >> So on Friday the latest CPI numbers come out. >> Yeah. >> And they're going to show the effects of the Iran war and they're going to show headline inflation going spiking in a quite dramatic way. Uh now the flip side of that is economists have always said don't pay too much attention to headline inflation. Headline inflation is what it is. It measures what it's meant to measure which is what's happening to the cost of living. Policy makers though should be thinking about what is the underlying inflationary momentum in the economy. And it turns out there are a few goods whose ups and downs don't say a lot about the underlying inflationary momentum in the economy. One of those is food. Why is that? uh things like droughts affect food prices and they don't affect underlying inflationary psychology and the other is actually oil uh energy and the reason for that is that we see things all the time go on in the Middle East that don't have much to do with underlying momentum in the American economy and so if we want to figure out what the underlying pace of inflation is that we can expect to continue over the next few years the real signal there comes from core inflation it excludes food and energy most of the serious economic models suggest that the oil price shock coming out of Iran will have quite a large effect on headline inflation but actually very very muted effect on core inflation. If the Fed were to take this view seriously that core inflation is not going to move very much and that unemployment's probably rising at a very slow rate that would suggest maybe the Fed ought to be somewhat doubbish. It ought to be thinking about lowering interest rates. I that's a view I take very seriously because I take our economic models and understanding of the economy very seriously. >> Well, right. >> Sorry, please. >> There's the the counterargument of the Fed, I can just explain the case and I think it's also a serious one is inflation expectations beget inflation. If everyone expects the cost of their inputs to rise by 4% and they expect their rivals to raise their prices by 4%, they think to themselves, I think I just got to raise my prices by 4% just to keep up. The concern at the Fed is higher gas prices, higher oil prices, higher fertilizer prices. Remember gas prices, it's the only price in the economy that literally is shown at 6 feet tall. Um, and the fear is this really shapes inflationary psychology. And the second fear is that the Fed has had inflation above its target now for 4 and a half years. And if we keep having inflation above its target, maybe an inflationary psychology will take hold where people begin to expect higher inflation and that causes higher inflation. And the Fed is desperately keen to tamp that down. So in this alternative story, what the Fed's worried about is not oil prices, but actually inflation expectations. And if it can keep a lid on inflation expectations, that's when it will feel comfortable to cut rates. >> Right now, the markets don't believe the Fed will raise rates. This is the CME Fed Wash tool. Um, so it's using bond market data to make a prediction. As of April, uh, sorry, as of today, April 9th. Uh, the expectation at the April 29th meeting is that the Fed funds rate will stay unchanged. And this expectation actually lasts throughout the year. um you don't actually get a meaningful percentage uh at either a 25 basis point cut or hike um at all until December 2026. Now, let's just say for the sake of argument the market's wrong, the Fed at some point raises rates this year, not lowers, raises rates. What happens if the Fed raises rates this year, Justin? What would happen to the economy? >> Okay, so actually, let me come back and set the stage a little more there. So you're you're exactly right to say what had happened. If you talked to me on February 27 before the Iran war, the market and the Fed basically all agreed there'd be some rate cuts coming this year roughly probably round about two. The Iran war happened two to three maybe. The Iran war happens there's this big spike in inflation in sorry in headline inflation which will come will be shown in the latest CPI numbers. Um, and the Fed relying on the sorts of economic theories I just described to you in response to your past question said, "Well, you know, that slows us down a little, but we still expect to cut rates." And according to the most recent Fed meeting, they still anticipated one to two rate cuts with a little bit more weight on one rate cut rather than two. Whereas markets move to saying there's no more rate cuts coming this year at all. So most of the debate is will the Fed stick with its expectation that it's going to look through some of the oil shock and still cut rates a little bit later in the year versus we don't believe they're going to do that they're going to be so embarrassed by these high inflation numbers they're going to feel that they have to raise rates. That's where most of the debate has been so far. You've just pushed us David to and I think by the way as a matter of history usually when the Fed says something if it says it in a careful and thoughtful way and the market believes something else I tend to believe the Fed. This is a case though where Jerome Powell I think was very clear at the last meeting. He said we really haven't done a lot of work factoring in the latest war. There was just no point like you may as well just wait and find out what happens and update your views after that. So this is a case where I think the Fed has shown a real willingness to be responsive to whatever changes are going to happen. So this could be a round that the markets win, in which case we end up with no Fed rate cuts this year rather than the one or two that they're currently pointing to. >> So let's take what the markets think. What happens if there's no cuts this year? What will happen to the economy? >> Right? So economic growth is a little bit slower relative to the counterfactual in which there had been. um >> in a world in which and you know how worried you are about that depends a lot on how you think we're currently doing. So if you think we're sort of doing okay right now and interest rates stay sort of like they are okay right now then you'd feel kind of comfortable about that. If you're on edge and you think that the economy is on the precipice of a recession and it needs some help to get us out of that and then this would really worry you. Um, and this comes back to the earlier question you're asking about how do you see what's going on with the labor market right now? Um, if you believe the labor market is showing um the latest if you believe the strength from the latest number then you'd say, "Oh, we're doing okay. We're fine without an extra rate cut." If you believe the San Francisco Fed that that okay is a weatherinduced illusion and we've been losing job we continue to lose jobs at a rate that we haven't seen in years then you're worried that the Fed's not ready to act to try and help us out right now. >> I think ultimately the average American and anybody in the world wants to know what are the economic conditions necessary for real wages to rise meaningfully. meaning my standard of living is going to beat inflation because my salary or wages will rise faster than the rate of change of the goods that I consume. Are we in that condition today? >> Not really. Um >> and we're not because of two reasons. Um one is tariffs and the other is the oil shock. So let me just briefly explain why that really makes a difference. So historically, your real wage, your spending power, that's what we care about, right? Um the idea that that is determined by the level of inflation doesn't really make sense when you think about it. Um now it might be for a little while, which is if prices go up rapidly, it takes a while to convince your boss that you need a pay rise. But we also know from looking at dozens of countries from dozens of decades, typically when prices rise, wages rise to keep up. takes a little while, but it happens pretty quick. And so therefore, your spending power is not determined by inflation. So, a lot of people right now don't feel that in their bones, but that's because they've grown up, David, you're, I'm guessing, younger than me. You've grown up where for most of your life, inflation's been really low. Those who are a little older than you, your parents' generation grew up, they experienced very high inflation through the 1980s, and they understood the deal. When prices rise, wages rise to catch up. Now there's something different though about a tariff induced inflation. So the thing is what normally would happen is if prices rise then the widgets that I produce my boss can sell them at a higher price. That means that the value in dollars that I produce for my boss are higher. My boss therefore wants to give me a pay rise in order to make sure I stick around. But when prices rise because your costs rise, say because of tariffs or an oil price hike, the boss no longer has more money left. The boss has no reason to give me a pay rise. And so a supply shock induced price hike is the one kind that's not going to lead to a corresponding wage hike. So in fact, it's much more painful. It actually leads it's it prices are going to rise without necessarily guaranteeing people's wages are going to catch up. >> We know that prices are sticky upwards, meaning when they go up, they usually stay high. But during a recession, we have deflationary forces. Do you see anything or any particular sector that has a higher chance of going down in price this year? I'll give you a personal anecdote and the one thing I have in mind is rent. Where I live in Vancouver, people are negotiating with their landlords to actually keep their rent st uh stable or mark down their rents. I actually know somebody who is a landlord who had to mark down his rent for the first time ever in his life. That's one example. Do you see anything else? >> Yes, but I want to start by drawing a very sharp distinction. So when economists talk about inflation, we mean a generalized rise in prices. >> Yes. >> Across all prices. When economists talk about deflation, we meant a generalized fall in prices across everything. What you're describing is instead a change in the price of one good relative to others. Um, and in your case, you're talking about Canadian real estate and Canadian rent and the Canadian rents might be falling. I believe some of that's also happening in the United States. When economists talk about the cost of deflation though, we're talking about the costs of a generalized fall in the cost of living, which is not what you're describing. Um, at any given point in time, there's actually lots of goods whose prices are falling. So, uh, you you talked about rent. Uh, my favorite one is the price of AI services. So, I code a lot. I make API calls to open AI and anthropic. The price of using those models like it halves every 3 or 4 months. It's a dramatic decline in prices. That's a specific example. But what we find generally is that technology products tend to fall in price over time, right? TVs just get cheaper and cheaper or they get better and better. Laptop computers are exactly the same. Phones exactly the same. Um, that doesn't upset the Apple card. Um, it might mean that you don't want to buy this year's model of PC or the latest iPhone because you hope you'll get it cheaper or you'll get a better one in a year or two's time, but the macroeconomic implications of that are pretty minor. >> Well, let's close off on your work. So, I mentioned in the beginning of the interview, you co-host a podcast with Bezie Stevenson, whom I've had the pleasure of interviewing actually on my show as well. Uh, Think Like an Economist is the name, and you're also starting a new show. What are some of the topics you'd be focusing on? Give us a teaser. >> So, that earlier podcast was really an audio course, which is if you want to learn economics and you can't be in my economics 101 course, go and take Think Like an Economist. Uh this David, honestly, I admire what you're doing with your audience, which is I believe the world would be a better place if we knew more economics. And it turns out that the university pays me to teach the to teach economics. And so what I want to do is is bring the superpower that is economics to people. Um I probably won't, you know, to some degree I'll follow the ups and downs of what's happening day by day, but I also think I may have bored some of your listeners right now. You might have noticed I have a tendency to teach rather than to talk. Um, and I think that when people understand what's going on in the world around them, the anxieties many of us feel right now actually fall. So, I think economics is a superpower. And I just want to teach people to learn how to fly. >> Well, I'm curious how how you would answer this final question I have for you. Uh, you teach economics to uh students every year uh at an entry level, you said. So, how would you explain to, let's say, a freshman in college how or why gold is trading at nearly $5,000 an ounce and has doubled in just a span of less than 18 months? >> Oh, wow. So, great question because the answer is I would tell them gold confuses the living crap out of me. And I don't know if we're allowed to swear, but um so let me answer a slightly different question, but I think they're related. >> Sure. >> Some students come to me and they say, "What's going on with Bitcoin? Should I invest in Bitcoin?" I'm like, Bitcoin is zeros and ones. It has no inherent value. I would never buy it. I believe there's a big chance one day the value of Bitcoin goes to zero. Now, this is where I want to show a moment of humility. This is where we come back to gold. Gold has no inherent value. It's a shiny rock. Like diamonds actually have industrial value, right? Where you can make drills and things like that out of them. Gold is just a shiny rock. It doesn't do much. Why would I want to pay anything per ounce for gold? Um, and it turns out people buy gold because they think other people value gold. And that's a self-sustaining equilibrium. The same thing is true of Bitcoin. So, look, if you told me the value of gold were to fall 97% tomorrow, I wouldn't be surprised. Uh, it would be that we all just stop believing that yellow metal is more important than yellow rocks are. At the moment, we seem to believe yellow rocks are more important than rocks of other colors. That's a social convention. That social convention could go away. >> But the narrative that gold is a counterdoll asset, I don't know if you agree with that first of all, but let's say you do. Does the price of gold rising the way it has signal to you that the dollar has lost or is about to lose purchasing power? >> Right. So, I sort of answered a different question than the one you're asking, which is this deep fundamental question like why do we care about a yellow rock? >> Yeah. And I said it's because of a social convention. Let's bring the two closer together, which is the social convention is >> it's a yellow rock that we all think will continue to be valuable in the future even if other assets aren't. >> That's why you might call it a safe asset. Now again, I just want to point out that's a social convention. So if I thought that my civilization was about to be blown off the face of the earth and the only thing that will persist are yellow rocks and the social convention that yellow rocks are better than other colored rocks, then I would want to buy a lot of yellow rocks. That's probably sort of a metaphor for what's happening right now. And if you want to sharpen the edges of that, I'm just going to say, David, you're probably better qualified than I am to answer that. I I I'm just wondering if the social convention is going to shift towards another currency that's not the dollar or a yellow metal in the future. Perhaps another fiat currency or perhaps a digital currency. And we'll close off here. >> Absolutely. I look, these are literally social conventions. This is things only have value if other people think they have value. Lots of people talk about the value of Bitcoin being that it's different than fiat money, but again, it's just I only believe these zeros and ones have value if other people believe they have value. >> Sure. >> Same fundamental problem, but money has existed now for thousands of years. It's a it's an amazing thing. And I've also been wrong about lots of things as well. >> Justin, thank you so much. Tell us where we can find your channel, your work, and when we can expect your new YouTube channel to to launch. Yeah. So, shh, it's a secret. Soft launch is underway right now. Um, so if you go to YouTube and look at Justin Wolver, if I haven't put you to sleep already at this point, Dave, it's far more interesting podcast and you feel like you want to learn a little bit of economics, uh, with an Aussie accent. Um, so I'm at Justin Wolfers on YouTube. I'd love to see you over there. Otherwise, I'm available on all the socials and we'll posting clips and all of that stuff. Um, but I'm excited to be I'm I'm excited, David, that we can enlarge this conversation and together maybe we'll teach the world economics. >> It's a remarkable world we live in. Two people on different sides of the world having a conversation and hopefully thousands of people will listen to us talk about economics. So, thank you for your work and contribution to social media. Justin, we look forward to following you on YouTube. >> Thanks, man. >> Thank you for watching. Don't forget to like and subscribe.