Podcast Summary:

Excess Returns – "The Fed Is Fighting the Wrong War | Jim Paulsen on Why 3% Inflation Isn't the Problem"
Date: December 2, 2025
Guests: Jim Paulsen
Hosts: Jack Forehand, Justin Carbonneau, Matt Zeigler

Overview

In this episode, the Excess Returns team introduces a new series, “The Jim Paulsen Show,” with renowned economist Jim Paulsen. The discussion revolves around macroeconomic trends, monetary and fiscal policy, the Federal Reserve’s priorities, and what really ails the U.S. economy. Paulsen argues that the obsession with fighting modest inflation is misplaced, as the real crisis lies in America’s diminished economic growth and fading "animal spirits." The conversation offers a data-driven critique of current policy, explores the underlying causes of slowing growth, and discusses investment implications for 2026 and beyond.

Key Discussion Points & Insights

1. State of the Market and the U.S. Economy ([01:10]–[08:24])

• Market Corrections and Setup for 2026:

  • The market has already seen a significant 20% correction, followed by a period of consolidation, creating a solid foundation for the new year.
  • Paulsen highlights sector performance shifts: from tech/communications dominance (early bull – 2022 to late 2024) to a recent broadening among S&P 500 sectors in 2025, reflecting a move toward greater policy accommodation.
  • Bond yields dipped below 4%, indicating potential for further declines and easier financial conditions.

• Leadership Rotation & Market Breadth:

  • Traditional "fear-based" assets like gold, money market funds, and the US dollar are losing momentum, while tech is quietly starting to underperform after a multi-year run.
  • "Tech is not collapsing, but the outperformance is starting to fade, which could spark changes in market leadership." — Jim Paulsen [07:50]

2. The Real Problem: Secular Decline in Growth, Not Inflation ([08:24]–[14:53])

• Long-Term GDP Downshift:

  • From 1950–2005, US real GDP growth averaged 3.5%; since the financial crisis, it’s barely over 2%.
  • Similar downshifts show up in household employment growth, labor force growth, and productivity. Unemployment duration has doubled.

• Ignoring Growth While Fixating on Inflation:

  • "We are fighting inflation...missing the fact that we're growing jobs at half the pace we used to in this country." — Jim Paulsen [10:48]
  • The fixation on inflation and the Federal Reserve’s 2% target distracts policymakers from the genuine risk: stagnating economic dynamism.

3. Underlying Causes of Slower Growth ([15:53]–[24:18])

• Demographic Headwinds:

  • Slowing population growth (fewer births, delayed family formation, curbed immigration) and an aging workforce reduce labor force expansion.
  • Lower productivity growth (now ~1.6%/year vs. 2.5% pre-2005) exacerbates the problem.

• Loss of Animal Spirits and Risk Appetite:

  • Americans and businesses have become more “de-risking” and less entrepreneurial, as seen in slower monetary velocity and declining leverage.

• Structural Issues:

  • Chronic trade deficits (average of 3.2% of GDP since 2006, up from 1.2%) siphon demand abroad.
  • Policy responses (tight monetary and fiscal approaches, anti-immigration stance, trade tariffs) are often contractionary rather than stimulative.
  • "We've lost animal spirits, which to me is the envy of the rest of the world in terms of American capitalism." — Jim Paulsen [18:39]

4. Questioning Technology's Productivity Impact ([24:18]–[27:46])

• Productivity Puzzle:
  • Despite significant digital/AI advances, measured productivity hasn’t accelerated. Distraction, entertainment, and concentration of gains in tech sectors may have limited broader economic effects.
  • "[AI]...can make weird images...not sure how much it moves the needle in terms of productivity." — Jim Paulsen [24:43]

5. Inflation: More Bark Than Bite? ([27:46]–[34:53])

• Current Inflation Levels:

  • CPI at 3% (historical avg 4%), PPI below 2% (historical avg 3.5%) — both are well below long-term norms.
  • The significant inflation spike post-COVID was "a supply-side phenomenon," not an entrenched, demand-driven trend.

• Misplaced Policy Priorities:

  • The Fed’s fight against inflation is likened to a battle against a ghost of the 1970s: "We're fighting them like they're runaway, like we're still stuck in the 1970s." — Jim Paulsen [27:47]
  • Real wages and profits have been resilient, countering the narrative of crisis.

• Tighter Policy, Wrong Context:

  • Historical monetary and fiscal contraction has been unduly harsh given today’s growth fundamentals.
  • "If we didn't have this weird 2% rule...we'd probably be talking about...promoting growth rather than fighting inflation." — Jim Paulsen [28:30]

6. Current Policy Stance: A Double Whammy of Contraction ([34:53]–[41:10])

• Persistently Tight Policy:

  • Money supply (M2) remains below trend, real rates are much higher than the post-2005 period, and the yield curve has remained inverted for a record period.
  • Strong dollar driven by high rates weakens U.S. export competitiveness, benefiting travelers but hurting domestic job creation.

• Taxation and Tariffs:

  • Aggregate government tax take has grown as a share of GDP (now 28% vs. 27% in the high-growth era), even as economic growth has halved.
  • Tariffs, rather than boosting inflation, add an additional tax-style drag on growth.

7. Solutions & Need for Policy Shift ([41:10]–[46:09])

• What Can Be Done:

  • Demographics can’t be changed overnight, but policy stance can.
  • Call for “policy easing” and a renewed focus on building optimism.
  • "We need leaders that say…we're going to bring your dreams back…and focus on getting growth going again in this country." — Jim Paulsen [43:07]

• Animal Spirits:

  • Chronic pessimism is stifling entrepreneurship; leadership and policy messaging must turn to opportunity and growth.
  • Policy focus should shift from inflation-targeting to stimulating demand and employment.

8. Investment Implications: Policy and Asset Performance ([46:09]–[56:29])

• Total Policy Stimulus Index (TPSI):

  • Paulsen’s custom composite index aggregates monetary, fiscal, currency, and yield curve signals to gauge overall policy stance.
  • TPSI was very weak during this bull market; as it picks up in 2026, expect a shift in market leadership.

• Asset Class Sensitivity:

  • Equal-weighted S&P, small-caps, cyclicals, and international stocks all historically outperform when policy becomes more stimulative.
  • "If we bring some policy juice, we're going to see a very different leadership in the market than we've had up to today." — Jim Paulsen [56:10]

9. Is Tech the Next Bubble? ([56:29]–[61:53])

• Parallels (or Lack Thereof) to Dot-Com:

  • Today’s tech valuations are high (TTM P/E ~45), but below the excesses of 2000 (P/E ~65).
  • This cycle’s tech outperformance has not been mirrored in the rest of the market (unlike '99-'00), so broader market collapse is less likely if tech falters.
  • The Fed is easing into tech's underperformance, the reverse of the delayed policy response in 2000.

• Rotation, Not Collapse:

  • Expect tech to underperform as policy shifts, but not a catastrophic crash.
  • "Tech...could come apart and a lot of the rest of the market doesn’t need to come apart like it did...after the dot-com [bubble]." — Jim Paulsen [59:10]

10. Outlook for 2026 ([61:53]–[65:04])

• Market Forecasts:
  • Paulsen suggests 2026 could deliver slightly above-average returns (potentially ~15-17% for the S&P 500) thanks to enhanced policy stimulus and rotation into previously lagging sectors.
  • Stresses the futility of precise forecasts: "Most every street estimate for the coming year will be way inside the average normal volatility error...it would have no significance whatsoever." — Jim Paulsen [64:22]
• Note on Volatility:
  • The normal volatility of the S&P 500 makes outcome predictions inherently uncertain.

Notable Quotes & Timestamps

• “We are fighting inflation...missing the fact that we're growing jobs at half the pace we used to in this country.” — Jim Paulsen [10:48]
• "We've lost animal spirits, which to me is the envy of the rest of the world in terms of American capitalism." — Jim Paulsen [18:39]
• "If we didn't have this weird 2% rule...we'd probably be talking about...promoting growth rather than fighting inflation." — Jim Paulsen [28:30]
• "We're fighting them like they're runaway, like we're still stuck in the 1970s.” — Jim Paulsen [27:47]
• "If we bring some policy juice, we're going to see a very different leadership in the market than we've had up to today." — Jim Paulsen [56:10]
• “Tech...could come apart and a lot of the rest of the market doesn’t need to come apart like it did...after the dot-com [bubble].” — Jim Paulsen [59:10]
• “Most every street estimate for the coming year will be way inside the average normal volatility error...it would have no significance whatsoever.” — Jim Paulsen [64:22]

Conclusion

Jim Paulsen delivers a compelling argument that economic stagnation, not mild inflation, is America’s true challenge. He advocates for a policy realignment towards stimulating demand, reviving animal spirits, and fostering optimism rather than constraining the economy with outdated, fear-driven policy. For investors, this could mean shifting market leadership and stronger returns for neglected sectors as accommodative policy gains momentum in 2026.

For further insights and charts, follow Jim Paulsen’s work at paulsonperspectives.substack.com.