Barry Ritholtz (7:35)

So let me ask you a question about that recession that never showed up. Forget 100% chance of recession. 22, 23, 24. Half of the Wall street economists were forecasting recessions. And no less an August and well regarded economist than Lawrence Summers was saying hey, you'll need 10% unemployment to bring this inflation down. What was it about the historical models that seems to have gotten this economic cycle so wrong?

Austan Goolsbee (8:10)

Well that's the critical question. And Summers said it either had to go to 10% or if it went to 6% it would take five years of unemployment above 6%. I think the thing that it got wrong, that worldview got wrong, is that it was rooted in almost all previous business cycles were regular demand driven business cycles. And that's the logic in a demand driven business cycle. You overstimulate, inflation goes up, inflation expectations go up and you have a hell of a time getting it out of there. As you know, I was an old dear friend with Paul Volcker and he was a mentor of mine and a personal hero really. And one of the lessons of the Volcker episode, which was a time when inflation expectations went way up, is that it's extremely painful if the Fed or the central bank does not have credibility. It's extremely painful to get rid of inflation in an environment where the Fed is credible. So that even as headline CPI inflation was approaching double digits, the Fed was announcing we will get inflation back to 2%. And if you go look at the market estimation from TIPS or from others, people believed it. If you looked at the what do you think inflation will be in five years? They were saying it will be back to 2%. That is a sign of credibility of the central bank. So A, you must have credibility and B, you must have the good fortune that positive supply shocks in our case, one, a big increase in labor force participation that was enabled, I think, by some of the more flexible work arrangements. Two, that we had had such a horrible supply chain experience coming through Covid with shortages, et cetera, that could heal. And then three, a pretty substantial uptick in the rate of productivity growth. That combination was a lovely combination that allowed inflation to come down without a recession. And I think that the, the ChatGPT AI version of a central bank would have got it wrong because it would have been based on a training sample, was a whole bunch of demand shocks. And this really wasn't a demand shock induced business cycle. And you don't look. It doesn't take somebody with the market acumen that you have, Barry. And it certainly doesn't take a PhD to look out and recognize that the COVID business cycle was driven by industries that are not normally cyclical. Normally cyclicals like consumer durables or business investment are the thing that drives the recession. And here the demand for consumer durables went up because people could not spend money on services. This is the only recession we ever had that came from people not being able to go to the dentist. And the thing about that is, like, the dentist is normally recession proof. And so that's why everybody should have been more humble in pronouncing what the future would be coming out of such a weirdo business cycle. And we're still kind of living with that.

Barry Ritholtz (11:52)

So let's talk about humility. You have specifically mentioned that the Fed needs to be, quote, more careful and more prudent about rate cuts due to the risk of inflation kicking back up again. So what specific inflation indicators are you watching closely in 2025?

Austan Goolsbee (12:14)

Okay, I'm thankful. Barry, I thought you were gonna be like, let's talk about humility. You once said, and I thought you're gonna feel like you're not a humble person. Look, my. I have actually been before we got to this dust in the air period where everybody's talking about major either geopolitical changes to conditions or changes of policy conditions that might affect inflation. I've been more confident, I've had comfort. We're still on the path to get inflation to 2% and we could cut rates. Now I'm open to being proven wrong. And if I adjust the I'm in the Data dog caucus. If, if the data come in and the outlook is changing, for sure I would change my view. But I think it's critical to answer your question specifically of what should we look at in inflation. I think number one, you want to look at the through line on inflation, not get overly indexed on monthly gyrations. It's a very noisy series. Okay. So looking over a longer period and what matters is the new months coming in the inflation. That's a 12 month backward looking average, which is usually what we're reporting it. 11 of the 12 months that are included in that are not new information. We already knew that. We knew, for example, that the blip up in inflation last January more than a year ago was going to fall out the back and so that it would be very likely that the 12 month average would start dropping here in the first quarter. But that would not be a sign that the inflation is falling right now. The inflation already fell. It is just like how we do the average. So number one, I put a lot of weight on the new months coming in and trying to get the through line of that, not just react to one month. And second thing that helps me that I find helpful is looking at the components of core inflation. Now I know it can drive people nuts, like it drive my mom nuts that we put our focus on core inflation and not food and energy inflation. Because my mom's like, what do you mean you're not paying attention to food and energy inflation? That's very public top of mind for her. It's because those are so variable, they're up, they're down. The we think the better observation is to look at core and then within core, there's goods, there's services, there's housing. Our problem has been goods inflation had returned to deflation and was looking good. Housing inflation's been the biggest puzzle and services inflation pretty persistent. The things that have given me a little more confidence lately is that even as we had a bit of a blip up in the inflation here, the components still look pretty good. The housing inflation has finally started falling on a pretty persistent basis as we've been wanting it to services getting closer, much closer to what it was pre Covid. Housing back close to what it was pre Covid. And the thing that has been firmed up here in the last couple of months has actually been goods. And the thing about goods inflation is, as you know and as some of my research showed before I ever got to the Fed, goods inflation over long periods is actually deflation. The 2% inflation that we were at before COVID was housing 3 and a half to 4 per year, services 2 and a half per year and goods minus a half to minus 1 per year. And so I think it's overwhelmingly likely that goods will go back to that very long standing trend. And as it does so, those are the kinds of things that give me confidence.

Barry Ritholtz (16:49)

So you mentioned housing. We seem to have two ongoing issues with housing. The first is it appears that since the financial crisis we've significantly underbuilt single family homes.

Austan Goolsbee (17:02)

Underbuilt, yeah, I agree with that.

Barry Ritholtz (17:04)

As the population and multifamily. So you have the population growing, you still have fairly decent immigration numbers. Too much demand, not enough supply. The first question is what can we do to generate more supply in housing? Do higher rates operate as a headwind against builders, contractors, developers putting up more housing?

Austan Goolsbee (17:31)

Look, this is a tangled, this is a tangled web that is critically important to the economy. You've seen the relative price of housing go way up post Covid. But the one thing that I want to highlight is yes, it's very noticeable, but it's not new. If you look like I said, for the whole decade plus pre Covid, you had half house prices going up three and a half percent a year, goods prices going down 1% a year. If you just compare housing relative price versus going to Costco, relative price, a thing that compounds 5% a year for 15 or 20 years, yeah, that's going to be a really big difference at the end of that time. And so I think one component that people are seeing and they're not wrong, you see the frustration of young people. They say, you know, when my, when my dad was, was 25 years old, he on one job could, could afford a decent house and I can't buy a condo. And they're not wrong. The relative price of housing has gone way up. I think some component of that is regulatory in nature and business permits. And I've been convinced by it by a bunch of the evidence that land use regulation have made it very difficult for us to build housing of any form, single family home, multifamily homes. I have a, I did some research that was about the construction industry and another thing going on is that overall productivity in the construction industry is not only been stagnant, it's actually over long periods of time been negative that we, we've gotten worse at building the same things that we did 20, 30 years ago. So I think that's part of it. And I think you're highlighting that rates do have a twin they do have a twinned effect. One is they affect demand, but the other is they do affect construction. And so I think in a higher rate environment, if you're trying to cool the economy, this is always true. But the shift of more and more of our mortgages to being 30 year fixed than they were, say in 2007 have meant that changing rates can have more of a lock in effect than and it kind of dull the immediate impact of monetary policy than it does in a more immediate mortgage impact environment.

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Barry Ritholtz (22:22)

Let's walk out a little bit about housing Owner's equivalent Rent has been this bugaboo for a long time that some people following the financial crisis said had understated housing inflation. Now there's some people saying something similar. How do we and I know the Fed has looked at this. There've been a number of white papers that have come out of the Fed, how should we think about the equivalent of renting versus ownership in terms of the impact on inflation?

Austan Goolsbee (22:56)

You raise several critical points if we're gonna walk out on housing and inflation. Point one, it's not single family home sales prices, it's owner equivalent rent plus rents. And the reason it's that is because part of buying a house is a financial asset. So if you're buying a house and the value is going up and you're selling it for more, and if there's speculation, that's not really housing, what you're trying to get, that's not really inflation, what you're trying to get for housing inflation is something like the cpi. How much more does it cost for the same housing services? And that's why they try to compute owner equivalent rent and similar. Point two, there's a heavy lag in the way they do it. So in a way the critics were correct that it was understating inflation on the way up. And the, the other critics are right that now it's overstating inflation on the way down for the same reason that it's kind of like if you were measuring average rent and people were raising, it was a time when the market was raising the rent. It's going to take time before that shows up in average rents because the contracts last for a year and 12 turning over. So you get this automatic lag in there. I think that has been a major component of measured housing inflation because if you go look at market based measures like from Zillow or others, they were showing rapid drops in the inflation rate back to, or in some cases even below what inflation was before COVID started. And so that's been the puzzle that has been our impatience. Why hasn't it shown up yet? That's been true for quite a while. And the lag theory, it should start showing up. Well, finally it has. And that's why I have a little more confidence that the housing inflation improvement will be lasting is it took a long time to run up and now it's finally started coming down. So I think it's probably got legs coming down. So I think those are two key components on the housing inflation side. We could even go into a third layer of wonky, but it's more subtle which is the component. If you think about rents and say market rents in Zillow or who are renters versus who are new home buyers, they're sort of different markets. And so it doesn't have to be that the inflation rate of the Zillow market Rents matches the owner equivalent rents that they're measuring at the bls because they might be different new renters and, and existing tenants might be a little bit too separate markets.

Barry Ritholtz (26:20)

Makes a lot of sense. You mentioned the 2% inflation target. In the 2010s, an era dominated by monetary policy, the Fed had a 2% inflation target. Now in the 2020s, we have a primarily fiscally driven economy or at least post pandemic, that's what it feels like. You've said you've turned 180 degrees on the inflation target question since your initial thoughts in 2012. Tell us about that. Explain that.

Austan Goolsbee (26:53)

Okay, so in 2012 there had been vague targets. In 2012 I believe is when the Fed officially said we have a 2.000% inflation target. And you go back and look, I wasn't at the Fed. I was critical. I was publicly critical on the grounds that that conveyed a way false sense of precision to me. That if I asked you just take the standard deviation of the inflation series and ask yourself how many observations would you need to get to be able to distinguish between a 2.0% inflation rate and a 2.1% inflation rate. And the answer was like decades. You'd need decades of monthly observation before you could tell no, no, this is 2.1, not 2.0. So that was my critique. Fast forward to the inflation now it goes way up. And the one wonky thing that you got to know what you already know, Barry, but the average person might not know is the 2.0% inflation target is for personal consumption expenditure inflation. PCE inflation. That's not CPI. It's a little different. They have different weightings of what goes into it. We believe the PCE measure, which instead of the CPI measures a basket and the PCE measures everything consumers spend money on. So it's the better measure. But just as a technical CPI of 2.3 is about the equivalent of a PCE of 2.0. Okay, we go through Covid. The inflation post Covid soars to almost double digits. In long run, inflation expectations measured in the market never go up. They remain exactly and they're off of CPI. Importantly they remain exactly 2.3%. And so I said either that's the biggest coincidence in the history of price indices or else the inflation target of 2.0 is serving as exactly the anchor that that its advocates said it would be. And at that point I changed 180 degrees. And I not only am I not opposed to the inflation target, I think it's critical. It's vital and it is serving as exactly the anchor that we needed.

Barry Ritholtz (29:41)

So. So it's a magnet, not necessarily a landing spot. Really interesting.

Austan Goolsbee (29:47)

You mentioned it will be the landing spot. It will be. You meant it'll get the 2%.

Barry Ritholtz (29:52)

You mentioned inflation expectations. When we look at some of the survey data in 2020 and 21, right before inflation really exploded higher, they were really low. And then go Fast forward to June 2022, just as inflation was peaking, they were really high. How close attention does the Fed pay to inflation expectation? It seems that it's very much a lagging, not leading indicator now.

Austan Goolsbee (30:22)

Fascinating in a way. A I should have said at the beginning, you know the rules. I'm not allowed to speak for the fomc, the Fed, only for myself. Yes, that gives them great relief. That gives my colleagues great relief. In the world of food safety, the thing that characterizes almost every worker in the food supply chain is frustration. Why do we have to wash our hands all the time? There's no, nobody's ever getting sick from the food and it's only because they're washing their hands all the time that nobody's getting sick from the food. I feel that way a little bit about inflation expectations. They are lagging indicators. If the Fed has credibility and is doing it right, as soon as that's not true, they become very instructive forward looking indicators. The only thing that I want to emphasize as well is now we've actually started to get a couple of observations where not short run expectations but longer run expectations actually bumped up in the University of Michigan survey. And since I had said this about how important inflation expectations were as a measure, a couple of folks asked me well does that make you nervous? And yes, but a I've always said I value the market based measures more than survey based measures and one month is no months. But make no doubt about it, if what we started to see was persistent, a persistent increase in long run expectations of inflation in surveys and market and for example, if you started to see long rates rising one for one with long run inflation expectations, then that fundamentally to me means the Fed's job is not done. And we've got to go address that because if you that's that's one of the main lessons of the Volcker experience and central banks around the world, if the expectations start rising, it is really hard to slay. You don't have to just slay the inflation dragon. You have to go convince people that it's going to stick. And it kind of the Only way we know, the only way we know central banks have been able to convey that is to have awful recessions where they grind down wages to convince people, look, that we will keep the job market as suppressed as we need to as proof that we're serious. So we don't ever want to get back into that situation if we can help.

Barry Ritholtz (33:06)

Last question on inflation. You have mentioned that prioritizing real economic channels the real economy over wealth effects. Can you, can you explain this perspective? Why does the real economy channels matter more to the wealth effects? I always thought the wealth effect was so dramatically overstated because, you know, it's typically the wealthy that owns most of the stocks and the real economy is the real economy. But I'm curious as to your perspective.

Austan Goolsbee (33:38)

Yeah, look, I would expand it a little more than just the wealth effect. My view is the Federal Reserve act tells us we should be looking at the real economy, maximizing employment and stabilizing prices. The stock market, other financial markets can influence those two things partly through the wealth effect. But by the very first speech I gave when I got to the Fed, I went out to Indiana and a factory where they make RVs, a community college where they train people for advanced manufacturing, and I said this. Look, the Fed by law, is supposed to be looking at the real economy and financial markets. To the extent they're affecting the real economy, we should pay attention to them. But that's it. Let's remember the priorities. I quantitatively agree with you. I think there are a number of people who overweight the wealth effect and its impact on consumer spending. And I don't want us to get into a mindset that the Fed has an accomplishment. If it does something and it changes the financial markets. That's an indirect. In my worldview, if you get the real economy right, the financial markets will benefit. But doing something to try to create higher equity prices or benefit the financial market, that should not be the Fed's goal. The Fed's goal should be stabilize prices, maximize employment, and focus on the real side.

Barry Ritholtz (35:17)

And if you do both of those, stock market tends to do well under those circles. Takes care of itself.

Austan Goolsbee (35:22)

And that's how it should be. That's how it should be.

Barry Ritholtz (35:25)

So you've mentioned that conditions have not materially changed despite recent economic data. Do you still expect to see interest rates a fair bit lower over the next 12 to 18 months?

Austan Goolsbee (35:38)

I still do. If we can get out of this dusty environment, look at the horizon and look at the through line, and when we're having a bunch of uncertainties that are about things that will increase prices. It's just throwing lots and lots of dust in the air and it's hard to see the through line. I still think that underneath there is a robust healthy economy with employment pretty much stable at full employment, inflation headed back to 2% GDP growth solid and strong. And we can get back to the resting point of normal in that kind of environment. If we're going to have an escalating trade war that leads to higher prices and a stagflationary kind of environment where GDP growth is falling, I could revise my economic outlook. But I still think if we can get past this dusty part over 12 to 18 months, the SEP dot plot tells you that the vast majority of members of the committee believe that the ultimate settling point for rates is well below where we are today. And so I still think that we can get there.

Barry Ritholtz (37:03)

And our final question. I love your self description. You have said I'm neither a hawk nor a dove, I'm a data dog. So now we have to add that's right, hawks, dogs. I don't want to hawks, doves and dogs. So explain how you as a data dog, how does that affect your approach to monetary policy, especially in 2025 where you're a voting member?

Austan Goolsbee (37:31)

I try to get out there. The first rule of the data dog kennel is that there's a time for walking and there's a time for sniffing and know the difference. And the time for sniffing is exactly when there is not clarity. Okay? And that is go get every data series you can, every frequency. Don't throw anything away. If you can get private sector price information, get it. If you are looking at the job market, don't just look at payroll employment when there's a bunch of stuff with population growth and immigration that make it noisier. Don't just look at the unemployment rate when labor force participation changes can affect it. Take ratios of unemployment to vacancies. Look at the hiring weight and the quit rate. Get out and talk to the business people in our regions and the kind of information that goes into the beige book. All of those things are more real time than just the data series. But that mentality that if you have a question, get out there and sniff. That's the essence of the data dog credo. If you want to look, it comes with some downsides. If you are more theoretical, ideological, there are times when you might be right and you can get to the answer quicker. But this seems like a very uncertain environment. Unusual, unprecedented business cycles. Nothing like things we've seen before. So just personally I'm more comfortable with that kind of approach.

Barry Ritholtz (39:12)

So to wrap up, if you're an investor interested in what's going on in the economy, looking at inflation, looking at monetary policy, it's simply not as black and white as you often hear about. Many of the voting members of the FOMC look at the data that's out there as complex and not binary. Don't think that what you're hearing in these headline reports are remotely giving you the full color of what's happening. There are obviously a whole lot of moving parts here, a lot of complexity, and it's reassuring when you hear from people like Chicago Federal Reserve President and FOMC voting member Austan Goolsbee, who are data driven, who do focus on filtering out the noise, but paying attention to the most recent trends but following the through line. It's not simple, it's complicated. We really need to bring a more intelligent approach than we often see. As investors. We think about what the Federal Reserve is going to do in response to what inflation is doing. Perhaps if we had a little more sophisticated approach and a little less binary, we wouldn't see people being so wrong about when the Fed's going to cut, when a recession is going to happen, what's going on overall with the robustness of the economy. Hey, it turns out that economics is hard. It's complicated. There are lots of moving parts. We oversimplify this at our own risk. I'm Barry Ritholtz. You've been listening to Bloomberg's at the Money. There are thousands of tech and business podcasts out there, but there's just one that you could count on for a weekly dose of the future. The A16 podcast from Andreessen Horowitz. This show brings you the world's most influential people movers who have a track record of being both early and right. Like Apple co founder Steve Wozniak or co founders Marc Andreessen and Ben Horowitz. Not to mention folks you typically don't get to hear from like the very first Chief Technology officer of the CIA. From the science and supply of GLP1s to what drove the recent Deepsea frenzy, to self driving cars, drones and even boats. Go ahead, eavesdrop on the Future with the A16Z podcast.