INSIDE ECONOMICS

Mark Zandi:                     Welcomed to Inside Economics. I'm Mark Zandi, the chief economist of Moody's Analytics, and I'm joined by a bevy of my colleagues, of course, my two co co-hosts, Cris deRitis and Marisa DiNatale. Hi, guys.

Marisa DiNatale:            Hey, Mark.

Cris deRitis:                      Hello.

Mark Zandi:                     Good to see you. And we've also got Bernard, Bernard Yaros. Bernard is our renaissance man, speaks 15 languages, is a guru, a squash guru. What else, Bernard, should I tell the world about you? And I'm not joking, [inaudible 00:00:45] think I'm joking and I'm not joking. Real renaissance man. Good to have you.

Bernard Yaros:                Thank you.

Mark Zandi:                     And Mr. Kamins, every time I see Adam on Zoom, I think of Dr. Zeus, because see those two doors in the back there? I don't know. It looks very Dr. Zeus like. I don't know. It's really, Chris, you don't see that?

Cris deRitis:                      Wow. No, not at all.

Mark Zandi:                     What do you see?

Cris deRitis:                      I see two doors.

Mark Zandi:                     Okay.

Marisa DiNatale:            It's like a Rorschach ink blot test.

Adam Kamins:                 That's right. Maybe it's what's made-

Mark Zandi:                      [Inaudible 00:01:18] talking about.

Adam Kamins:                 Everyone sees something different in my basement here.

Mark Zandi:                     Yeah, yeah, yeah, very much so. Hey, and my sound, I'm a little remote. I forgot my microphone, which I can't believe I forgot my microphone, but I'm here in New York. I spoke at the RMS conference. Good group of folks, so several hundred people. And I had influence, so I did a poll at the beginning of my talk and I said, "How many of you think the probability of recession over the next 12, 18 months is greater than 50%?" And I tell you, 95% of the hands went up. I gave my talk. I said, "Okay, let's do the poll again. How many of you think the probability of recession is greater than 50%?" And I think I got them down to 30% of the hands went up. So I don't know. What do you think? I didn't realize I was that persuasive. Maybe because these were all risk guys. So maybe they're easily persuadable. I'm not sure. But they definitely changed their mind. You skeptical Chris?

Cris deRitis:                      Was there lunch or happy hour after you? Is that the...

Mark Zandi:                     Is that what you think it was?

Cris deRitis:                      No. I don't know.

Mark Zandi:                     "Get that guy off the stage." Huh?

Cris deRitis:                      "Let's get going."

Mark Zandi:                     "Let's get going. Make him happy. Make the economist happy. Let's just get going." I should say, we have our own conference. Right? The economics team has its conference. And that's coming up June, when is that, June 20th I believe? Is that right?

Cris deRitis:                      Yes, that's right.

Mark Zandi:                     And it's in Wilmington, Delaware. Of course we picked Wilmington because it's very close to our suburban Philly office. Well, former office. Right? Because we are now fully remote, but it's equally distant between D.C. And New York. And also of course, Wilmington has a pretty sizable group of financial institutions that are mostly consumer finance. And so we thought that'd be a good spot. But we'd love to see you there at that conference. And if you're interested, let us know. We'll make sure you get an invitation to that because that'll be very good to have you. And I think we're all, are all you guys speaking at... Or I know, Chris, you're speaking at the conference. Yeah.

Cris deRitis:                      I am.

Mark Zandi:                     You are. Okay. On house prices I believe?

Cris deRitis:                      Yes. Housing generally.

Mark Zandi:                     Housing generally, yeah. Very good. So that should be good. Okay. We've got a lot to talk about here today. We've got a lot of inflation news this past week. Of course, the all important consumer price index. I thought we'd run that down a little bit and talk about inflation, inflation prospects, what it all means for monetary policy and the economic outlook.

                                           I also want to talk about the debt limit. We talked a bit about that last week, but Adam and Bernard did a lot of really good work here trying to understand what the potential impact of a debt limit breach might be on regional economies, state economies more specifically. I want to go through that.

                                           And then of course, I want to play the game, the sixth game. And we've got a lot of players, so that should be fun. And listener questions. As you may know, we've been collecting questions from folks out there and Marisa's been compiling them and we're going to go through a few of those if we have time to do that. Sound like a good game plan? Everyone's good with that. Okay. Very good. Okay, let's go. Let's turn to inflation. And I guess the headline is the consumer price index for the month of April. Marissa, do you want to give us the rundown?

Marisa DiNatale:            Sure. We also got the PPI last week, but people really care about the CPI. Right? So let's do that first. So CPI rose 0.4% month over month. That was true for both headline CPI and for core CPI. On the headline that was a little bit softer than we were expecting, we were expecting it to tick up half a percentage point, core was right in line with expectations. The increase in CPI and the acceleration over the prior month when prices advanced in March 0.1% was expected because we knew there was a tick up in gasoline prices over the month. And indeed, that's where most of that increase comes from. Core on a month to month basis stayed the same pace as it was in March. And it's really been averaging that 0.4% month over month for about the last nine months. It's been in the 0.3, 0.4, 0.5 range for the last nine months.

Mark Zandi:                     Core being?

Marisa DiNatale:            Core excluding energy prices and food prices, is what core inflation is. And we strip those out because they can be very volatile from month to month. On a year-over-year basis, however, total CPI fell to 4.9% year over year, down from 5% in the prior month. And that's the slowest pace of growth since May of 2021. Core advanced 5.5% over the year, and that's also a 10th lower than it was in March, the year-over-year reading. It's been pretty much 5.5% percent year over year since the start of this year. And just for context, the peak in core year-over-year growth was 6.6% back in September.

                                           Getting into some of the details about these movements, food prices were flat over the month. Grocery prices declined, but that was offset by an increase for the second month in a row in food away from home, so dining out kind of food. That keeps rising grocery prices are falling or flat. Energy prices rose 0.6% in April after falling in two of the previous months. However, that was all in gasoline and motor fuel prices. Utility prices, energy services fell over the month.

                                           Core goods prices were up over the month, thanks to a very large increase in the price of used vehicles. So used vehicle prices were up 4.4%. And that was the first time used vehicle prices have risen since June of last year. On the other hand, new vehicle prices fell a bit, 0.2% over the month, and that was the first monthly decline in new vehicle prices since April of '21.

                                           I think probably the most interesting thing to delve into in the report was the prices of shelter. So shelter prices make up a very large portion of the overall CPI basket. They make up more than 40% of the CPI basket. And we've been talking about this on the podcast because it's really key that we start seeing some deceleration in shelter prices in order to get the CPI inflation back down closer to the Fed's comfort zone. So shelter prices decelerated for the second month in a row. So they rose 0.4% month over month, but that was slower than in March, which was slower than in February, which sounds good on the face of it, but if you dig into it a little bit more, the only reason that shelter prices decelerated was because hotel prices had a very big drop.

                                           So included in shelter is rents, owner's equivalent rent, which is the implicit price a homeowner pays to him or herself to basically rent their own home. And then there's lodging away from home. So the lodging away from home prices fell 3% over the month, whereas owner's equivalent rent stayed the same at 0.5% month over month. And rent prices actually ticked up a 10th of a percentage point from 0.5% to 0.6% in April.

                                           Other categories, medical care services and transportation services fell over the month. The prices of those things fell. And then finally, something we're watching, and Bernard, I know you calculate this and that the Fed is keyed in on, is so-called super core inflation, which is core inflation, so again, stripping out energy and food prices, but also stripping out rent prices. Those rose 0.3% month over month for the second straight month. Super core is up 5.1% year over year. That's the slowest pace of year-over-year growth since May of last year.

                                           So bit of a mixed bag, mostly good, I think. Curious to hear what you guys think, but I don't think this is anything that's going to change the Fed's mind in their coming actions for the rest of the year. And I'll just briefly tell you that the PPI came out as well for the month of April. That was up 0.2% month on month in April.

Mark Zandi:                     Producer price index.

Marisa DiNatale:            Producer price index. So this is sort of like before the prices get to more wholesale type prices, before they get to final sale. So those rose after they fell for in March and they were unchanged in February. So this is the first increase in producer prices since January. But over the month, producer prices are up 2.4% and that's the slowest rate of growth since January of 2021. And for context, they peaked at 12% in March of 2022, right after Russia invaded Ukraine.

Mark Zandi:                     Great. So that, that's a lot of great detail. Big picture, consumer price inflation, CPI inflation peaked in June of 2022 last summer, around 9%, depending on whether you seasonally adjust or you apparently don't seasonally adjust, but let's just say 9%. As of April of this year, that's year over year, it was 9%. Year over year as of April, the last data point, we're down to 5. And in our forecast, our baseline most likely outlook for the economy, we have CPI inflation going back to the Federal Reserve's target, which we estimate for CPI to be 2.5%. So we go from 5 to 2.5% roughly over the next year.

                                           So when we have this conversation a year from now, we'll be back close to the Federal Reserve's target, at least as measured by the consumer price index. Obviously, there's the other index out there that the Fed focuses on, the consumer expenditure player and that's where they spend most of their energy. That's a 2% in target. I'm not going to go into any detail here. We've done this before on the podcast, but that's the baseline. So Marisa, that outlook feel right to you? Is that consistent with your thinking?

Marisa DiNatale:            I think it's according to script, as you would say. Yeah.

Mark Zandi:                     According to script.

Marisa DiNatale:            Yes. Yeah. The only thing that we have to start seeing is rental prices start to come down more. Right? They've not moved very much for several months. And that's key, I think to this forecast, is that we get the price of housing in the CPI to start moving downward, which we're expecting will happen pretty quickly. This report was for April and we've been predicting that we would start seeing some of that down downward movement around June-ish. Right? So middle of this year. So we still have a little bit of time to see if that forecast comes to fruition, but we want shelter prices to move lower, since there's such a huge component.

Mark Zandi:                     Okay. So let me provide more color there in terms of the baseline outlook. And then I want to turn to Chris and Bernard and Adam to get their reaction to it. I thought those CPI number was pretty darn good. Inflation's too hot, no doubt about it. But it's cooling and it does feel like it's headed back to the Fed's target here, to script as you say, by this time next year.

                                           And I feel like I can say that with more confidence because I feel confident, to your point about the cost of housing services. That is going to decelerate. I know that it's going to happen because that's tied to rents, ultimately, with a long lag. And rents have gone flat to down since the end of last year, through the early part of this year, for good fundamental reasons. There's a lot more supply coming into the market as the supply chains ease and labor markets normalize on the other side of the pandemic, we're just going to get a lot more multi-family rentals constructed. And there's less demand because the previous surge in rents, young households, can't afford the rent, households aren't forming. That's demanding destruction. I feel really very confident in that. And that's a third of the plus of the CPI index.

                                           I also feel very confident in further declines in vehicle prices. That decline in new vehicle prices that happened in April, we've been waiting for that for quite some time. And that feels like that's a start of a trend of negative monthly price numbers here going forward, because we're getting more supply there, too. Japan, Germany couldn't produce enough vehicles because of their supply chain issues, which were more pernicious than the ones here in the US, but they're figuring it out now. And we're getting more supply, more cars on dealer lots. We had Mike Brisson on with Jonathan Smoke and they're on board with the idea that we're going to see vehicle prices decline. I feel very confident about that.

                                           And the last piece of the puzzle is that super core you mentioned, which is very tied into labor-intensive service activities, from healthcare, to hospitality, to personal services and educational. That's labor-intensive. That goes to wage growth, that goes to the Fed's efforts to slow the economy's growth rate down, ease the labor market pressures, get unemployment moving a little bit further north, getting wage growth down so that inflation on the service side of the economy can come in as well. There I feel less confident, but I'm feeling more and more confident that that's going to happen, given what's going on in the rest of the economy, labor market, wage growth dynamics and everything else.

                                           So I feel pretty darn good. And by the way, that's all going to happen, in my view, without a recession and without any further increases in rates by the Fed. The Fed, I think is done, that the federal funds rate target is now just over 5% given the last rate move that occurred a week ago. And that's the end of the story. Okay. I just said a lot. Feels like a pretty sanguine, reasonably sanguine outlook, a slow session outlook, not a recession outlook. Let me turn to Bernard, because I'm letting Chris kind of gear up here to respond. But let me go to Bernard. Bernard, what do you think of that, what I just laid out there for you? Are you on board with that or would you push back on that?

Bernard Yaros:                No, I'm definitely on board on that and I think we're not giving enough credit to... We are we are starting to see some signs of housing disinflation. So if you look at the year-over-year growth in the CPI for rent of shelter, so that includes the rent that tenants are paying as well as the owner's equivalent rent, which is the hypothetical rent that a homeowner would have to pay themselves to stay in their home. That has already peaked. It peaked in March. And for the first time ever, since early 2021, it's no longer rising year over year.

                                           And this is important. I wouldn't say that this is a fluke because rents are sticky. Once you have a trend, once you see a trend in rental prices, that has staying power. So I would expect we are starting to see the whites of the eyes of rental disinflation, that's going to continue, and it's going to be an even larger source of disinflation on the overall CPI and especially the core CPI, just because of the new weights or the new relative importance ascribed to shelter and especially to rent of shelter, is the largest it's been since at least the late 1990s. So that's really going to help bring us... I think that's going to help contribute to the sanguine inflation outlook that you laid out.

                                           I would also like to make one point about used vehicles. Used vehicles were a major sort... They added about 15 basis points to the month-over-month gain in the core CPI. But I-

Mark Zandi:                     0.15%. So that's a pretty big number. 0.15% we're seeing. Right?

Bernard Yaros:                It's a big number. Yeah.

Mark Zandi:                     Okay.

Bernard Yaros:                And I would expect in the next month or so, we're probably going to get a few more hot prints for used car vehicles. But it's not going to persist for that long because we are already starting to see wholesale used vehicle prices, which tend to lead retail prices by up to three months. Those have started to fall, at least starting in the month of April.

                                           And then I'd say the other big statistic we got this week was the Senior Loan Officer Opinion Survey. And that also showed that over the first quarter, banks were tightening their lending standards for new and used auto loans and even auto loan demand weakened over the first quarter. So it just feels that used car vehicle prices are not going to be adding significantly for that much beyond the very near term.

                                           And then within core services, excluding rent of shelter, so this is the super core measure, there were a lot of pockets of weakness, rental vehicle prices were weak, airfares were down. And this actually comes as domestic airline capacity is finally rising above 2019 levels. The weakness in lodging away from home, that also was consistent with other data I've been looking at, such as average daily rates for hotels. So those pockets of weakness also make me feel comfortable in the super core measure, which the Fed is keyed into, that we should see some further easing. And there already we've seen a lot of disinflation at least year over year.

Mark Zandi:                     Got it. Okay. Chris, so where is this forecast wrong? Or is it? You're on board with this or not?

Cris deRitis:                      I'm on board certainly with the idea that inflation is going to come down. We have a lot baked in the cake that you and Bernard already mentioned. Right? Housing is just going to take time. We can already see it right from other data, there's no question there. And I agree with the used car price is probably a little bit of a fluke there and new car price is certainly on the way down. So I'm not disputing that. I'll even throw you one more and this will then lead to my next point. Big declines in lodging. Right? So what do we say? 3.6? What, 3.4% on the month?

Mark Zandi:                     Yeah, that was large.

Cris deRitis:                      Hotels.

Marisa DiNatale:            Yeah.

Cris deRitis:                      Big declines in car rental prices, down 3.2 in the month. Big decline in airfare, down 2.6% on the month. And sporting events, also big, I can't remember what, I think 7, 8, something like that on the month.

Mark Zandi:                     Oh, is that right?

Cris deRitis:                      What are all those categories have in common? They're all tourism. Right?

Mark Zandi:                     Yeah.

Cris deRitis:                      All discretionary spending. Right? That's the first thing that consumers will-

Mark Zandi:                     By the way, that's not consistent with the cost of the ticket to go to see the Sixers play the Celtics. I don't know where that's coming from.

Marisa DiNatale:            Playoff tickets excluded.

Mark Zandi:                     Oh, okay. Okay. Fair enough.

Cris deRitis:                      Well that this is April. Right?

Mark Zandi:                     Core recreational service prices then.

Cris deRitis:                      That'll show up in May.

Mark Zandi:                     Oh, in May? Okay, go ahead. It's seasonally adjusted anyway. Yeah.

Cris deRitis:                      So I see a consumer that might be a bit weak here. Right? That's certainly helping with the inflation coming down, but my fear still is that we overdo it. Even if the Fed doesn't hike anymore, there's a lot of weakness already built in here.

Mark Zandi:                     Oh, so you're saying that, yes, inflation-

Cris deRitis:                      Inflation down.

Mark Zandi:                     But that might be a window into some weakness in consumer spending on services, which has been kind of helping support growth here, is that what you're saying?

Cris deRitis:                      That's right.

Mark Zandi:                     Oh, interesting.

Cris deRitis:                      So we always talked about the consumer firewall. Right?

Mark Zandi:                     Yeah.

Cris deRitis:                      Is that the first chink perhaps in the...

Mark Zandi:                     Oh, in the firewall? Okay. Well, of course it is important to put it in a bit of context. And I don't know that data as well, but in my mind's eye, there were some months with some pretty large increases in all those-

Cris deRitis:                      No doubt.

Mark Zandi:                     All those things.

Cris deRitis:                      No doubt.

Mark Zandi:                     So it's almost like they're just coming a little bit back down to earth compared to where they were, but oh, very interesting. Okay. And are you also on board with the idea that the Fed probably has ended its rate hikes here? Given that inflation outlook, given what's happening in the labor market, job growth is slowing, we talked about that last week on the podcast. Given financial conditions which have clearly tightened given the banking crisis, it feels like, at least for the foreseeable future, we're not going to see any more rate hikes here from the first, or are you on board with that as well?

Cris deRitis:                      I am, especially given that last point. Because I don't know that the financial banking turmoil is over.

Mark Zandi:                     Is over

Cris deRitis:                      Still some cracks in the foundation.

Mark Zandi:                     Okay. And so I take all that, what I just said, and conclude, well, that makes me feel more comfortable that we're going to be able to navigate through without an economic downturn of recession. But that's not where you go, your mind goes?

Cris deRitis:                      It certainly is helpful, if we had seen-

Mark Zandi:                     Helpful. Okay.

Cris deRitis:                      If we had seen a different report here, if inflation had been really robust and not showing these signs of weakness, then it'd be a different story. So it gives me a little bit more hope, but I still see some of the other downsides here as well.

Mark Zandi:                     Got it. Before we leave the topic of inflation, I want to turn to you, Adam, because you do a lot of work with understanding what's going on with the regional economies. And inflation's been an issue across the country, obviously, but it's been more a problem in some parts of the country than others. Do you want to explain what you've uncovered there?

Adam Kamins:                 Sure. So there been some interesting dynamics there. So if you go back to when inflation really started to spike, it was pretty clear that the places where the demand side of the economy was especially strong, Mountain West, Southeast, they were experiencing especially high inflation. So we were seeing markets like Phoenix, Atlanta, Tampa, where inflation was twice the rate at some points, compared to what it was in New York, San Francisco, some other markets along those lines.

                                           The last, probably starting about six months ago, I would say, end of 2022 into 2023, we start to see some convergence there, where the economies that we're struggling for a lot of the pos-pandemic era were picking back up. I think we were seeing the demand side strengthen there. House prices start to maybe normalize a little bit more in some of these hotter markets. And I think you were seeing some convergence in terms of inflation. But interestingly, the last couple of months we've actually seen the Northeast in particular start to come down again a little bit more rapidly than the rest of the country. So we're seeing some gaps open up again, where New York actually experienced a little bit of above average inflation for a few months relative to the US, and actually has experienced, along with Philadelphia, disinflation now over the last couple months. So prices have actually fallen in a couple of those markets, whereas nationally, obviously they're still rising.

Mark Zandi:                     What do you mean disinflation or deflation? You mean disinflation. Slower growth in, no?

Adam Kamins:                 I mean that prices actually have declined than a month-over-month basis in New York and in Philadelphia, just over a couple of months. But I guess-

Mark Zandi:                     Oh, 'cause of energy prices, I guess? No?

Adam Kamins:                 Yeah, and I think part of it just, there's volatility in the regional data, so I don't want to read too much into that. But yeah, I think part of that would be energy prices. The shelter costs measures, we don't have as much granularity in terms of whether it's driven by lodging or by the rental market or what segment of the housing market it may be. But definitely softer of late in the northeast. And I think some of that reflects the fact that some of these broader headwinds around bank failures, tech layoffs, we're seeing that clearly in California and in the west, but also affecting office using markets. Places like New York, Boston, D.C., I think all of that has been kind of a drag on the demand side of the economy and it's pushing inflation a bit lower than elsewhere in the country.

Mark Zandi:                     Okay. In my thinking about regional inflation, my sort of working thought, is that the big differences are generally around the cost of housing services, which goes back to rents. And so if you're in a market where housing is very strong, absorption strong, rent growth very strong, that results in strong array of inflation because housing's such a big part of the CPI. And that is a large reason for the higher rates of inflation in the parts of the country where the housing market was... It was juiced everywhere, but particularly juiced in the western part of the United States, and you mentioned Florida. And now that the housing market's cooling off, that those differences are abetting, generally speaking, is that roughly right?

Adam Kamins:                 That's roughly right, but we've seen that start to kind of unwind a little bit the last couple of months. So it's something I'm watching now to see if those gaps reopened a little bit. But everything you described, I would say, if you asked me that two, three months ago, I say that's spot on. It's exactly what we've seen. Last couple months, the story's starting to change a little bit it looks like.

Mark Zandi:                     Okay. We'll stay tuned. We'll see. Okay. Very good. The one thing that people didn't call out and I'm just going to throw it on the table, not that we have to talk about it. The thing that really worries me about how I could be wrong, why the forecast of getting back to the Fed's target inflation rate of 2.5% On the CPI by this time next year, is medical care inflation. Because we've been getting a string of declines in medical care service inflation for some wacko reasons, going back to the way the BLS measures this thing. And that that's going to reverse itself, and that's where I worry. Bernard, just say yes or no. Do I have that right?

Adam Kamins:                 Yeah, you have that right? Yes.

Mark Zandi:                     Okay. All right. Very good. But that's really going into the DNA, and maybe we'll do that next time. We'll do that that time. Okay. Let's play the statistics game. And we got a lot of players. The game is, we each put forward a statistic. The rest of the group tries to figure that out with questions of deductive reasoning, some clues. The best statistic is one that's not so easy, we get it right away. Although Marisa's getting everything right away, I don't know how we solve that problem. And I won't say ChatGPT, but I just won't say it. She's mad, she's upset. She's so upset, she's still on mute. She doesn't know she's on mute. Oh, there you go. And not so hard that we never get it. And if it's a plus if it's a statistic that came out this week irrelevant to the topic at hand. Okay. The tradition is, we go with Marissa first, although I'm sort of starting to rethink that tradition, but we'll stay at least one more a week with that tradition. Marissa, you're up. What's your statistic?

Marisa DiNatale:            My statistic is 46.7%.

Mark Zandi:                     46.7%. Is it the statistic that came out this week?

Marisa DiNatale:            Yeah.

Mark Zandi:                     A government statistic? Senior Loan Officer Survey? The Fed is a government agency.

Marisa DiNatale:            Yep. Yep.

Mark Zandi:                     Okay. See how she does that, Bernard? She does like a head thing. She delays to make you think, "Oh, maybe it's not a government entity."

Bernard Yaros:                Or it's ambiguous.

Marisa DiNatale:            Well, I had to pause because they are independently... They have some independence.

Mark Zandi:                     Yeah. Okay.

Marisa DiNatale:            Okay. Fine. Fine. Yes.

Mark Zandi:                     It's part of the [inaudible 00:30:16].

Marisa DiNatale:            It's from the Senior Loan Officer Survey.

Mark Zandi:                     And is that the net percent of senior loan officers that said that standards for C&I loans, commercial industrial loans, is tightening?

Marisa DiNatale:            Yes, but you need to be more specific.

Mark Zandi:                     Okay. I'm going to be very specific. For small-

Marisa DiNatale:            Yes.

Mark Zandi:                     Banks. Okay. Bernard.

Marisa DiNatale:            Small businesses.

Bernard Yaros:                For small businesses.

Marisa DiNatale:            Small businesses.

Mark Zandi:                     Oh, sorry. I said small banks. Small businesses. Small businesses. Sorry about that. Small businesses. Bernard, you see how that's done?

Bernard Yaros:                Yep.

Mark Zandi:                     I'm just saying, you see how that's done? That was masterful, right, Chris? You don't have to say it.

Cris deRitis:                      Nice. It was very nice.

Marisa DiNatale:            He interrogates you to death.

Mark Zandi:                     But you knew that, didn't you? You let me do that on my own? You knew the answer to that question, didn't you?

Bernard Yaros:                No, no.

Mark Zandi:                     Oh, you didn't? Okay. Great. Okay. Very good. Now I feel better. Okay. Explain, Marisa.

Marisa DiNatale:            Why did I pick this?

Mark Zandi:                     Yes.

Marisa DiNatale:            Well, I mean, Bernard mentioned it when he was talking about lending on auto loans. So I'm looking at the Senior Loan Officer Opinion Survey pretty closely for lending to businesses. And in particular, small businesses because small businesses account for a lot of the job growth in the country. And if small businesses, who are much more likely to go to a bank for credit than a big business who can tap capital in debt markets, if they can't get financing, then they can't invest in capital, they can't hire.

                                           So this is an increase, obviously this has been rising now for some time, several quarters. About the last year we've started to see banks saying that they're tightening lending standards. And this is the tightest that lending standards have been since we were coming out of the Financial Crisis. So coming out of the recession that started in late-2007 and in early-'09. So this is as high as they've been since then, and higher than any tightening on the series that we saw even during the 2001 recession. So you have to go back, after '09, you have to go back to the 1990s to see a number this high in the number of the net percent of banks tightening standards on small businesses.

Mark Zandi:                     You know what struck... Oh, sorry, go ahead.

Marisa DiNatale:            I was just going to say, following all the turmoil in banks, with SVB and First Republic, we've been waiting for readings to show us how lenders may have reacted to this, if they're battening down the hatches, expecting tighter credit or raising the cost of funds, and they are indeed doing both of those things.

Mark Zandi:                     You know what struck me, and maybe there's a good explanation, this survey that you're mentioning was done after the crisis, but if you go back to the survey that was done in January before the crisis, the difference between the two, not that big, maybe a little bit of an increase in the net percent saying they're tightening their underwriting. And this is not just for C&I, but commercial real estate, for credit cards, all types of lending. There was some further ostensible tightening and underwriting, but not as much as I thought might have happened, given just how significant the hit to the banking sector was. Did that strike you as well?

Marisa DiNatale:            Well, looking at this series in particular, I thought it was interesting that the jump was bigger in the first quarter report between the first and the fourth, than it was between this report and the first quarter. So standards tightened more at the beginning of this year before the banking turmoil than they did since the banking turmoil.

Mark Zandi:                     Now, of course, it's kind of cumulated. Right? Because you're tightened in Q1 and now you're saying I'm tightening again.

Marisa DiNatale:            Right.

Mark Zandi:                     So the amount of tightening is quite significant. I'm not saying that, but I thought we'd see more of an increase. Chris, are you of the same mind? Were you surprised or was that what you expected?

Cris deRitis:                      Well, I guess I expected it actually to be in this range because banks had already tightened so much.

Mark Zandi:                     Okay.

Cris deRitis:                      Right. So how much more can you tighten?

Mark Zandi:                     How much more can you tighten, I guess. But I'm not going to lend. I can't not lend any more if I'm not going to lend, so.

Cris deRitis:                      Right, right. And a drawback of the survey is that it doesn't really tell you anything about the magnitude.

Mark Zandi:                     Yeah.

Cris deRitis:                      Right? It just tells you I'm tightening, but is that a little, is that a lot? It could range across different institutions as well. So it's a good measure. It's an important measure, but it's not a complete measure from that standpoint.

Mark Zandi:                     Yeah. The other thing that struck me, and this goes to the Federal Reserve, H8 data. This is the balance sheet information from the banking system. And you look at C&I loans outstanding. You can see that how much commercial and industrial loans, again, those are loans from banks to businesses, that are on the books of the banks. That fell when the crisis hit. But it's been stable since then and it doesn't indicate any further decline or weakening in C&I loans outstanding. And that's the case for both small business and for larger business. Have you noticed that as well?

Cris deRitis:                      No, I didn't see that.

Mark Zandi:                     You didn't see that, Chris?

Cris deRitis:                      No, no.

Mark Zandi:                     Oh, yeah. So I'm almost coming to the conclusion that the banking crisis is obviously an additional headwind, but it's not like a hurricane. At least so far, as you-

Cris deRitis:                      At least not yet. Right?

Mark Zandi:                     It may not be over, for sure. The bank stock, the regional bank stocks are still under a lot of pressure. And we need more data and evidence, but so far it doesn't feel like this thing is as serious, certainly as it could have been, or is certainly what I was fearing. No?

Cris deRitis:                      I think there's a demand response. Businesses, consumers just not applying for credit because they have a feeling they wouldn't get it in the first place.

Marisa DiNatale:            Well, demand has weakened quite a bit. Right? When you look across all these categories, and the Senior Loan Officer Survey asked, not about tightening standards only, but they also ask about demand for all these kinds of loans and lines of credit. And that's weakened across the board. So fewer businesses are asking for credit.

Mark Zandi:                     Yeah, but I keep going. Well, the link between the banking crisis and the economy, at least in my mind, is banking crisis, underwriting standards, loan growth, economic activity, banking standards tighten, but not as much as I feared. And then loan growth, it's not growing, which isn't great, but it's not balling, which is good. So makes me more comfortable that the banking crisis isn't going to undermine the thing that does the economy in. At least, again, so far. Yeah. Anyway. Okay. All right. Bernard, you're up. What's your number?

Bernard Yaros:                My number is 6.1%.

Mark Zandi:                     The way he said that, he was kind of disappointed in his own number. Right? He goes, "Oh, 6.1, it's not even a really good number." Yeah. Too easy.

Marisa DiNatale:            Is it from the CPI?

Bernard Yaros:                From the what?

Marisa DiNatale:            Is it from the CPI report?

Bernard Yaros:                No, no, no.

Cris deRitis:                      Oh.

Marisa DiNatale:            No, no, no.

Mark Zandi:                     Is it a government statist?

Bernard Yaros:                Yes, it is.

Mark Zandi:                     It came out this week?

Bernard Yaros:                It came out just today.

Mark Zandi:                     Oh, it came out today? Well, what came out today? UI claims?

Marisa DiNatale:            EPI?

Cris deRitis:                      [inaudible 00:38:07] claims?

Bernard Yaros:                No.

Cris deRitis:                      PPI.

Bernard Yaros:                We don't cover it on EV.

Cris deRitis:                      Oh. Okay.

Mark Zandi:                     Oh. Now, that's an invitation to look at on what's EV.

Bernard Yaros:                No EV, it's talked about a lot here.

Mark Zandi:                     I don't know, guys. Do you guys know?

Marisa DiNatale:            Is it an financial variable measure?

Bernard Yaros:                To give you a hint, it's tied to labor.

Mark Zandi:                     Oh, what came out? It's not in the jobless claims numbers?

Bernard Yaros:                No, no.

Mark Zandi:                     No. Okay. Which were a little disappointing, weren't they? Or a little surprising, I guess, sort of right?

Cris deRitis:                      Yeah, they jumped up.

Adam Kamins:                 They were a little high.

Mark Zandi:                     They jumped up 260, 2000 initial weekly claims, although that's pretty consistent where you'd expect it in a typical economy, wouldn't you, Bernard? Or is that hot too? Is that higher than you feel comfortable with?

Marisa DiNatale:            It's 1000 claims below the breakeven point of no job growth, I think.

Mark Zandi:                     Really?

Marisa DiNatale:            Yeah.

Mark Zandi:                     That feels [inaudible 00:39:09].

Bernard Yaros:                Yeah. There's been a quirk in UI claims. I think that's due to there's some court going on in Massachusetts. So UI claims non-seasonally adjusted have been, I think doubled over the past two weeks.

Mark Zandi:                     Oh, so something weird is going on?

Bernard Yaros:                And this has happened before in Massachusetts. I'm not quite sure what exactly is.

Mark Zandi:                     Okay.

Bernard Yaros:                Yeah, the Massachusetts UI data has been squirrelly a few times since the pandemic.

Mark Zandi:                     Yeah. Really weird. Okay. Well, okay, that's interesting. Okay. Put us some out out of our misery. What release is it?

Bernard Yaros:                It's the Atlanta Wage Growth Tracker.

Mark Zandi:                     Oh, that's a good one. Yeah, go ahead, explain. Yeah.

Bernard Yaros:                So the Atlanta Wage Growth Tracker, it's tracking the median year over year percent change in the hourly wage of individuals. And this is the three-month moving average. So it's a bit smooth, it doesn't capture, because the underlying data is quite volatile. And it's down only marginally from 6.4% in March. So this is still... It shows that wage growth has peaked, but it's been pretty sticky at the low 6% range. And this is still way too high of a pace for us to be really at a labor market that's consistent with 2% inflation. And for that, we really need wage growth to settle closer to 3.5%, assuming underlying productivity, about 1.5%.

                                           And I would say the big reason why wage growth is still too elevated is because there's still a lot of excess demand in the labor market. Nationally, labor demand, which we like to define as the sum of employment and job openings, is greater than labor supply or the labor force by close to 4 million. And some of the past work that we've done shows that this excess to labor demand really needs to shrink from 4 million to at least 2 million for wage growth to settle around a target 3.5% pace.

                                           And because Adam's here, I'll add a regional angle, we've also estimated about three quarters of this reduction in excess labor demand really needs to come from the South. And this is not just due to the size of the South population wise, but also because of how strong it's labor market is. So in this respect, I would say the South is presenting the biggest challenge to the Fed as it's trying to restore balance to the labor market.

Mark Zandi:                     Well said, but I don't buy it. I don't agree with it. I don't want [inaudible 00:41:45] this whole excess labor demand thing, but I'm not going to go into it here, because that would take us down a whole nother path. But I got to have you on, I got to work on you, Bernard. I got to work on you.

Cris deRitis:                      That's a different script.

Mark Zandi:                     That's a different script. Yeah, that's a different script. But I hear ya. But that was a good one. Good statistic. Adam, you want to go next?

Adam Kamins:                 Sure. Although I'll admit I made the rookie mistake of blowing through my statistic when I was talking about the CPI number. So I'll give you a different one. It's not-

Mark Zandi:                     That is a rookie mistake.

Adam Kamins:                 Yeah, yeah. This is not from this week, but it's relevant to the topic at hand that we're going to talk about after this, about the debt ceiling topic.

Mark Zandi:                     Oh, the debt ceiling. Okay.

Adam Kamins:                 So the number is $662 billion.

Mark Zandi:                     It's something to do in the budget, the federal budget?

Adam Kamins:                 Adjacent to the budget.

Mark Zandi:                     Adjacent to the budget. Okay.

Adam Kamins:                 It's related to the federal government.

Mark Zandi:                     Oh, okay. Ooh. And it's related to the debt limit. Is it the amount of interest payments, the dollar amount?

Adam Kamins:                 No. So it's a category. If you're looking at what the federal government-

Mark Zandi:                     Spends its money on.

Adam Kamins:                 Spends its money on, yes.

Mark Zandi:                     Non-defense, discretionary spending, XVA?

Adam Kamins:                 You're in the ballpark. It's a little bit more general than that.

Mark Zandi:                     Oh, because I think total discretionary spending is what, Bernard? You know that number one point?

Marisa DiNatale:            Is it just non-defense spending?

Adam Kamins:                 Yeah. 1.4. Yeah.

Mark Zandi:                     Non-defense discretionary spending?

Adam Kamins:                 I think you guys are close enough. I'll tell you what I'm getting at. It's government spending on contractors in particular.

Marisa DiNatale:            Oh.

Mark Zandi:                     Oh. 'Cause that's important to the work you did on the debt ceiling?

Adam Kamins:                 That's pretty crucial to how we're thinking about the implications of the debt ceiling. I can hold off on that if you want to until we get to that topic or come back.

Mark Zandi:                     We'll come back.

Adam Kamins:                 Okay. We'll come back to that.

Mark Zandi:                     But this goes to you regionalize the impacts of various debt limit scenarios and this was an important piece of information with regard to how to do that?

Adam Kamins:                 Exactly. And one way to put that in context, that's basically $2,000 for every American that that's associated with government contracts to the private sector. So it's a very significant part of the economy.

Mark Zandi:                     Okay. Yeah. We'll come back. Chris, you're up.

Cris deRitis:                      4.4%.

Mark Zandi:                     In the CPI report?

Cris deRitis:                      No.

Mark Zandi:                     A government statistic?

Cris deRitis:                      Yes. I'll take the Marisa path. It's from a Federal Reserve Bank.

Mark Zandi:                     Oh, Federal Reserve Bank. Is it related to underwriting standards? Oh, it's a delinquency rate?

Cris deRitis:                      Nope,

Mark Zandi:                     It's not a delinquency rate?

Marisa DiNatale:            Is it something that came out this past week?

Cris deRitis:                      It came out on May 8th.

Mark Zandi:                     4.4%. Is it something on the fed's balance sheet?

Cris deRitis:                      No. It's related to the CPI. Related to inflation.

Mark Zandi:                     Oh, related to inflation.

Marisa DiNatale:            Does the St. Louis Fed have some sort of inflation-

Mark Zandi:                     Oh, I know. It's the median... It's one of those wacko Cleveland Fed-

Cris deRitis:                      No, no, no.

Mark Zandi:                     The measures of dispersion of-

Cris deRitis:                      The mean. No.

Mark Zandi:                     The mean, the median, the 16th percentile. It's none of those things?

Cris deRitis:                      It's none of those things.

Mark Zandi:                     Inflation expectations?

Cris deRitis:                      Yes.

Mark Zandi:                     Oh.

Cris deRitis:                      [inaudible 00:45:23] New York Fed.

Mark Zandi:                     Okay.

Cris deRitis:                      New York Fed, one year ahead, consumer expectations for inflation. So 4.4-

Mark Zandi:                     Oh, okay. It was 4.1?

Cris deRitis:                      4.4.

Mark Zandi:                     Oh, 4.4. Okay. Is that up or down or where?

Cris deRitis:                      Well, it's down from March. This is the number for April, down three tenths, but still above where it was in February, where it had been down to 4.1.

Mark Zandi:                     Okay. Where was it at the peak?

Cris deRitis:                      At the peak. It was something like 6.7, 6-

Mark Zandi:                     Bernard, just to make the point, this is why wage growth is so high. This is the issue in my view, not excess demand. I know you're listening to Chair Powell too much. You got to listen to Mark Zandi a little bit more. I'm just saying, I'm just saying. I'm teasing, I'm teasing. Oh, that was a good one. Okay. I got a good one. It's hard though.

Marisa DiNatale:            Is it going to be a set of numbers?

Mark Zandi:                     No, it's one number. Actually, I ran across it today. 62.3%.

Cris deRitis:                      That is the percentage of job satisfaction.

Mark Zandi:                     Oh, yes. Very good. I was hoping you would say that. And I could be the one-

Cris deRitis:                      That was my backup.

Mark Zandi:                     I knew it was. I knew it. Excellent.

Marisa DiNatale:            What is that? Percent of job satisfaction where? Here?

Cris deRitis:                      Generally. Go ahead, Mark.

Mark Zandi:                     [inaudible 00:46:46] board, there's a survey and they've been doing it for 30 some years where they ask a number of questions, I think 26 questions and all about job satisfaction. "How do you feel about your job?" That's basically the bottom line. And 62.3%, and Chris, correct me if I'm wrong in the way I'm articulating this, but 62.3% of respondents said that they like their job, they're pretty good with it, they're satisfied. That is a record high.

Marisa DiNatale:            Really?

Mark Zandi:                     Yeah. And the conference board, and it made sense to me, ascribes this to the fact that wages are up across a lot of industries, where in the hospitality industry, for example, they're way up, retail way up. The other is all the jobs switching that occurred allowed people to get a job that's consistent with what they want to do in their interests. And they're very happy with it. And I guess remote work probably has also played a role. People are pretty happy with the ability to get that flexibility from remote work.

Cris deRitis:                      Yeah. Well-

Mark Zandi:                     I thought that was pretty cool... Pardon me?

Cris deRitis:                      I thought that was a really interesting point in terms of the satisfaction of people who like the flexibility, who want the remote work, but also want the in-person experience.

Mark Zandi:                     Yeah. Yeah.

Cris deRitis:                      It's the hybrid experience.

Mark Zandi:                     The hybrid experience, yeah.

Cris deRitis:                      Not remote work itself, but the combination.

Mark Zandi:                     The flexibility, really.

Cris deRitis:                      Yeah.

Mark Zandi:                     Yeah. I was surprised by that.

Marisa DiNatale:            That's interesting.

Mark Zandi:                     And very different from the consumer sentiment surveys. Right? Everyone says everything's awful, miserable. We're going into recession but, "Oh, I love my job. I love my job."

Cris deRitis:                      That's like your...

Mark Zandi:                     What's that, Chris?

Cris deRitis:                      It's like your congressman. Right? Or congressperson.

Mark Zandi:                     Yeah, exactly.

Cris deRitis:                      Your yours is great, but everyone else is terrible.

Mark Zandi:                     Anyway. Okay. That was a really good one. A way to play it, man. I was waiting for you to say 60 point points.

Marisa DiNatale:            How did you know that, Chris? Because you were going to pick it.

Cris deRitis:                      It was in the paper today.

Mark Zandi:                     Yeah, it was in the... I saw it on the web somewhere. Somewhere on the web. Okay. Let's go back to the debt limit. And Bernard and Adam and I updated these debt limit scenarios where we've been examining what would happen to the economy, assuming we went down different paths for the debt limit, the different types of breaches of the debt limit or different types of government responses to address the debt limit. And this time, we not only refreshed updated the scenarios, but we went and tried to figure out what the regional impacts were. And here, we've really focused on state economies. And maybe, Bernard, I'll turn it to you and maybe can provide more color around our thinking and what results we got. And then we can get down and dirty with this with Adam for a few minutes and get a better sense of what he learned from doing this work.

Bernard Yaros:                Sounds good. So we considered only two scenarios. So one was a short breach scenario. So this assumes that we arrive to June 8th, which is our estimated X date or the date at which the treasury will run out of cash and no longer be able to pay all of the government's bills in full or on time. So in the short breach scenario, we hit the X State, lawmakers do nothing, and a week passes by where the treasury is scrambling to get enough tax revenue to pay its incoming obligations.

                                           And it lasts for a week. There's not too much of a direct fiscal contraction. So we hit the X date on June 8th, but then just a few days later, around mid-June, you get another surge in tax receipts. So these are largely corporate tax receipts as well as quarterly estimated tax payments by individuals who have their taxes regularly withheld from their paychecks.

                                           And this provides a lifeline for the treasury, in this case. It limits the direct contraction in federal spending that would be required. But still, I would call this to very similar to the TARP moment back in 2008 when the bank bailout legislation failed and stock prices cratered. That applied a lot of political pressure on lawmakers to reverse course and ultimately pass the legislation.

                                           So even though you wouldn't really have social security benefits or other payments being disrupted, the financial markets would be very rattled, and that would apply pressure on lawmakers to reverse course and raise or suspend the debt limit. So here, just at the national level, a recession would still result, but it would be relatively mild, with a close to 1% peak to trough decline in real GDP, employment would decline by 1.5 million jobs, and the unemployment rate would rise from 3.4% to almost 5%.

                                           And just for context, a 5% peak unemployment rate, that still wouldn't be quite as bad as what we saw during more milder recessions like the bursting of the dot-com bubble. But the wealth effects would really kick in, stock prices would be lower, and confidence would also be lower. So that would be enough to tip the economy into a mild recession, even though you have relatively quick action.

                                           We then considered a second scenario. So this was what we called the prolonged breach scenario. So once again, we hit June 8th, lawmakers do nothing. And the assumption is here is that they wait all the way till the end of July to actually get their act together and raise or suspend the debt limit. And the reason why they wait this long, we assume in this scenario is, because as I mentioned, in mid-June, you have another surge in tax receipts. Through June, the treasury's able to meet all of its bills, and so that reduces the urgency for low on lawmakers to address the debt limit.

                                           However, in July, they continue to do nothing. But in July, this is typically a month where the treasury runs a budget deficit. So it's taking in much less revenue than it's spending out. And over this period of time, you get delays to all sorts of payments, buildup, buildup, buildup, until the treasury has to cut its spending to match revenues by about $140 billion. And for context, if you annualize that, that's close to 6%, six or 7% of GDP. So that's a not insignificant amount of money that's being taken away from the economy. So the direct fiscal contraction there is quite large.

                                           And ultimately, we assume by the end of July, lawmakers get their act together. They raise or suspend the debt limit. It just wouldn't be tenable for this to continue much longer, especially once you start to have more than 60 million social security recipients, for instance, not being paid on time. But here, this sort of bookends the worst possible outcome. You have a peak to trough decline in real GDP by 4.6%. You have 7.8 million jobs that are lost, the unemployment rates rises to 8%, and stock prices decline by about a fifth, wiping out $10 trillion in household wealth.

                                           And right now, there's a lot of debate about fiscal sustainability and the importance about reducing the federal budget deficits over the long term. And that's all well and good, but if we go down any of these dark paths, it actually leads to worse federal fiscal outcomes because of a weakened, diminished economy and higher interest rates that result from this extreme political dysfunction, you actually have an even higher debt to GDP ratios 10 years from now. So in our baseline, we assume the debt to GDP ratio 10 years from now is close to about 116%. Whereas in this worse case scenario that we consider the prolonged breach, it's even higher at 136%. So it's really, in terms of fiscal sustainability, it really backfires going down this dark path.

Mark Zandi:                     Of course, our baseline is not those two scenarios. Right?

Bernard Yaros:                No.

Mark Zandi:                     Our baseline is that after a lot of drama, some volatility in markets, some declining at stock prices and gapping out of credit spreads, lawmakers will kind of figure it out, they'll suspend the debt limit until that line it up with the decision around the '24 budget. They have to get this done to also keep the government open then on October one. So they have to raise the debt limit and they have to fund the government. They kind of marry those two things. And by so doing, they can generate the rhetorical political victories that both sides needs to sign on a piece of paper and get this legislation through and get it done. It's not going to be graceful, it's going to be pretty ugly, but at the end of the day, they're not going to breach. But these scenarios were designed to say, "Hey, what if we're wrong and they do breach? What would it might look like?" And we book ended it. The first one was kind of the least bad outcome. The second, the prolonged breach, was probably as bad as it's going to potentially get.

                                           Okay. That great. And for folks that are interested, this is on a paper that's in the public domain. I think it's called Debt limit update, I think. Something pretty simple. So you can find it there. Okay. As I said, we took this down to the state level, try to understand what all this meant for different state economies. Adam, do you want to kind of summarize what you did and what the results are?

Adam Kamins:                 Sure. So what we did was really focused on both model driven channels that would transmit directly from our US model to our state model. Those would be things like government output and employment directly, financial services, and just the general cyclicality of some parts of the country versus others. So states that typically face more severe downturns, Arizona, Florida, Michigan, ones that are really cyclical, Nevada being another one also are hit harder. All of that transmits directly from the US to our state model. And those channels are fairly straightforward.

                                           But that that's not enough to really capture the idiosyncratic nature of this shock regionally. So we also hit a number of what we consider kind of indirect channels to state economies. Maybe the most important is the one that I mentioned earlier, which is federal contracting dollars. So we know that there are hundreds of billions of dollars at stake just from federal government jobs directly. And so if those are at risk, and obviously not all those jobs would be lost, but if a good percentage of those jobs are lost, that has a very significant negative impact on the economy.

                                           But we also have that $600 billion plus number of federal contracts that are out there, that are going into the private sector. So we looked at data from the government on where that money is going, and you can actually get this down to the state, even down to the county level to understand where there's the greatest dependence. You can also look at that at an industry level.

                                           So we're able to determine, for example, that in Virginia, the white collar industries in Virginia are very highly dependent on the federal government. And that's no shock. We were able to quantify exactly how dependent they are and understand that Connecticut, which is a very big manufacturer of aerospace equipment, aircraft, ship building that goes right to the government as well, understanding the degree to which the government is contracting with firms in that state. And we were able to make adjustments to output employment in each state based on those data. That was probably the most significant adjustment that we made.

                                           But then we're also looking at reliance on government support in terms of social security, Medicare, Medicaid, what that can mean for the economy. So in some cases, states that have higher levels of poverty and that depend more on programs like Medicaid or on food assistance, on the SNAP program, those face greater hardship. States that have a larger share of seniors could face disrupted payments to social security, Medicare.

                                           And it's important to note that even if payments are briefly disrupted, or even if they're not disrupted at all, just the uncertainty and the concern that will pervade consumers in these scenarios means that spending is going to decline, that healthcare usage could decline. So we look at healthcare systems, especially in rural areas as being at particular risk as well. And then we're looking at financial markets and wealth effects and trying to make some adjustments to income levels and have that flow through the rest of the model.

                                           So we made all of these different custom adjustments, and where we end up is with initially the shock that takes place, and that would be really concentrated in the second half of this year, is in primarily, of course, Washington D.C. is it harder than anywhere else. It basically sees an immediate or almost immediate spike in the unemployment rate by about five points, goes from about 4% to about 9% right off the bat.

                                           A number of other states that are highly dependent on the federal government, so I mentioned Connecticut and Virginia, New Mexico, Alaska, Alabama, some other ones that just rely very heavily on government contracting or government payments get hit very hard immediately.

                                           And then as the recession evolves, what basically happens is that that recession begins to take on a life of its own. And it looks more and more in a lot of ways, like the Great Recession back in '08, '09, where the states that are traditionally more vulnerable to a deep recession. Again, the tourism and travel dependent states, the manufacturing dependent states, they're the ones that have a much tougher time emerging.

                                           So in a Washington D.C., for example, there's a very steep shock initially, but federal government payrolls go back to basically what they were before the situation kind of worsened initially and before the breach of the debt ceiling. And so you see those economies kind of get back to at least something resembling normalcy, where the unemployment rate is still very elevated, but moving in the right direction. But some of these more cyclical economies have a much tougher time getting on track, and they don't until late 2024, even into 2025.

Mark Zandi:                     Let me ask you this, Adam, was there anything that really surprised you? Any state or region that got hit or didn't get hit that surprised you?

Adam Kamins:                 I was surprised, and it seemed a little counterintuitive at first, but I think it made sense the more I looked at this. Just the fact that these manufacturing-centric states in the Midwest get hit hard, or as hard as they do. So states like Michigan and Ohio, where the way I was thinking about this initially was this is not a typical recession, and it's not right. I think there's this first phase that we're looking at where government contracting and reliance on the government is really central to what happens.

                                           But I think what really struck me is the fact that there is this much more rapid rebound in certain states that I would've thought would would've borne the brunt throughout. But when you think about it, I think, the federal government still serves as a stabilizing force, I think, by the time you get to 2024 in those states. And just the fact that this begins to look in terms of which states are hit harder, more like a typical recession, I think that did surprise me at first. And first, I felt like I had to convince myself, but the more I think about it, I think that that is very intuitive and I think that that actually does make sense, and it's the way that a situation like this would unfold.

Mark Zandi:                     Excellent. Well, thanks for all that. And interestingly enough, got people out there in the world really found this very interesting. Got picked up in a lot of different places. So good work. Okay, we have a few more. I'm want to not belabor the debt limit discussion too much, one, because it's getting a little late in the podcast, but also, we're going to come back to this, I have a feeling a lot over the next few weeks, so-

Cris deRitis:                      Could I ask one quick question?

Mark Zandi:                     Yeah, yeah. Fire away.

Cris deRitis:                      All right. So it clearly laid out the downside risk. I'm wondering if anyone has looked at the other side of this. Could you argue the Republican Stand. So it's a big game of chicken, negotiation that's going on here. What if the Republicans actually get what they want? What are they fighting for? What is the potential upside of the economy, if any, that you see?

Mark Zandi:                     If the piece of legislation, what was it called? The-

Adam Kamins:                 Limit Save, Grow, Act of-

Mark Zandi:                     Limit, Save, Grow Act, did that got passed into the law?

Cris deRitis:                      Yeah.

Mark Zandi:                     Okay. Well, we-

Cris deRitis:                      Because that's the debate here. Right?

Mark Zandi:                     Actually, we did do that and you can go see the results. And just to summarize very quickly, it cuts the growth on discretionary spending going forward, doesn't stipulate defense, non-defense VA, but in all likelihood, when you sat down and did it, it would be non-defense, non-VA, NASA, air traffic control, national parks, all those are things that would be cut to some degree, along with a lot of other stuff, housing assistance and food assistance and so forth and so on.

                                           And a number of things sort of outside the budget process, tax credits for green energy, that was part of the Inflation Reduction Act, roll back all the things that President Biden wants to do with student loans, easier permitting, cheaper permits for fossil fuels, claw back of COVID, really a bunch of stuff.

                                           I'm not a fan, the thing that... I'm not a fan, two things. One, the budget cuts begin right away in the fourth quarter of 2023. What does everyone think might the world look like in the fourth quarter of 2023? According to you, Chris, we're going into recession in the fourth quarter of 2023, or close too.

Cris deRitis:                      Yeah, especially if you're-

Mark Zandi:                     Yeah, and you want to cut. But me, a significant cut to government spending when the economy is already on the precipice of recession, I'm not a fan. Second thing is, I do think we need to address our long-term fiscal problems through restraint on government spending plus increased tax revenue. But I don't know that I would focus on poor old non-defense, non-discretionary spending to do it, because under current law, that was going to fall anyway as a share of GDP, and it's already nowhere. It's not any higher today as a share of GDP than it was, I don't know, 25, 30 years ago.

                                           So if you want to solve that problem, addressing our long-term fiscal problems, you're barking up the wrong tree. That's not where you want to go. You want to focus on the obvious, Medicare, Medicaid, social security, that's where you have to go. So I'm not a fan about the longer term, the thrust of this. It's not getting to the meat of the matter or the heart of the problem, and it's cutting where you probably nobody really wants to cut anyway. So that's my view. But you can find it in the paper. Bernard, did I get that roughly right?

Bernard Yaros:                Yeah, yeah. And in response to Chris's question, I think-

Mark Zandi:                     Are you saying I didn't answer his question, Bernard?

Bernard Yaros:                No, no, no. You-

Cris deRitis:                      I know.

Mark Zandi:                     It's okay. It's fine.

Bernard Yaros:                I would add to that, one upside could be if we actually do get some entitlement reform, but in the way that we did it early on in the Reagan administrations with respect to social security. Again, that's a very long shot that something like that actually happens, but if we were to get immigration reforms, entitlement reform and some tax reform, broadening the base, for example, I think those would be very small, but they are upside risks in all this.

Cris deRitis:                      I guess my question is even more direct or specific. I agree, lots of things need to happen here. This is not the best way to do anything. But let's say the Democrats concede for the greater good and they say, "Okay, Republicans, you get everything you want in your plan. What happens to GDP, unemployment, the economy over the next couple of years? Is this-

Mark Zandi:                     Well, it gets hurt.

Cris deRitis:                      A drag.

Mark Zandi:                     We go into recession.

Cris deRitis:                      We go into recession anyway. Right?

Mark Zandi:                     Or we get pretty close. We don't actually go in, do we, Bernard? We get-

Bernard Yaros:                GDP growth is so slow that you get-

Mark Zandi:                     We lose jobs.

Bernard Yaros:                Yeah, you lose jobs.

Mark Zandi:                     It's right on the edge. Yeah. In the near term. In the longer run, it's not significant in terms of what it means. Yeah. I thought you were asking what, is there an upside scenario here? Could something actually turn out better than anticipated? And I'm not sure there's much upside, other than just increase the debt limit, let's move on and get to the next time we have to address this thing. That's probably the best scenario, but that's the scenario everyone's expecting anyway. So I don't know that there's any upside.

                                           I suppose you could do the 14th amendment. I'm not going to go down that path, but that could end up in a better place actually. Right? Because if you invoke the 14th Amendment and say, "The debt limit legislation effectively is not constitutional, I'm not going to abide by it." And the Supreme Court says, "Yeah, you're right." You've now obviated the debt limit as legislation and that goes away. I would view that as a major victory because the debt limit's becoming a real problem and it's going to become an even bigger problem going forward, given the political environment that we're facing and will continue to face going forward. What do you guys think? Do we have time for a question or two, Chris, or you're saying no? Should take a question or two?

Cris deRitis:                      I'm always up for it.

Bernard Yaros:                Just one.

Mark Zandi:                     Okay. It's a little long. If the listener out there is tired, you want to leave, go ahead, but you're going to miss the best two great questions that Marissa's going to pose.

Marisa DiNatale:            Or one question.

Mark Zandi:                     And two great answers. We don't know what the questions are. She hasn't told us, but fire away, Marissa, give us your best shot.

Marisa DiNatale:            Okay. This is an interesting question in light of your statistic, Mark, and Bernard's. Okay. This came to you on Twitter.

Mark Zandi:                     To me, personally?

Marisa DiNatale:            You personally, at Mark Zandi. Okay. "Work from home and hybrid opportunities are expanding individual labor markets. There is the potential for quicker and better job matching. Shouldn't we expect lower frictional unemployment with potentially lower structural unemployment, too, going forward, if this is the new norm?"

Mark Zandi:                     That's my view. Yeah, I think that with remote work, as businesses work through all the moving parts here to make remote work really work, that we will get better matching, people will find better jobs, businesses will find better workers, and that should lead to less friction in structural unemployment. So the natural rate of unemployment, the so-called NROU, I think will be lower. I think that's a long time in coming because to make to make remote work as our economics group within Moody's is figuring out, because we went remote, there's a lot of things you have to work through and make work well to fully empower this as a tool for better labor matching.

                                           But my sense is, that as we work those things through, and we will over time, then indeed I do think this will be adopted more widely across the country because I do think workers want it and they'll ultimately get it. And as new businesses form, I think they're going to form, not based on some office using experience, but on a more remote work experience, maybe a hybrid model that these problems will be addressed and we will see better matching and the natural rate of unemployment will be lower. We're not talking a percentage point lower. We're talking a 10th or two, maybe three, something like that. So kind of on the margin meaningful, not inconsequential, but I'm not saying we're going from 4% to 3. I think we're going from 4% to maybe 3.6, 3.7, something like that. Chris, what do you think?

Cris deRitis:                      Yeah, I agree with that. I'd emphasize the degree of the-

Mark Zandi:                     The degree?

Cris deRitis:                      Is to my mind, is going to be pretty small. Most jobs still can't be done remotely.

Mark Zandi:                     Good point.

Cris deRitis:                      So yeah, we'll get some better matching, but I wouldn't expect a significant or very large decline in the national-

Mark Zandi:                     Can anyone channel Dante? Because I think Dante has it, Dante DeAntonio, our other colleague who's a labor market economist, really good one. Doesn't he have a different view on this, a different take? Does anyone recall? No. Okay. We'll have to get him back from-

Cris deRitis:                      He has a different take on productivity.

Mark Zandi:                     Yeah, I know on productivity, I thought on this labor matching issue, too, he had a different perspective, but no. Okay. All right. Let's do one more, Marisa. That was a good one.

Marisa DiNatale:            Well, there's one person who wants to know what they should write their thesis about, if we have any ideas for them, and there's another person who would like to know if they should buy a house now or wait till next year.

Mark Zandi:                     Well, I guess the question is, can he find a house?

Marisa DiNatale:            Let's not do the house.

Cris deRitis:                      Yeah, that's right.

Mark Zandi:                     Yeah. The thesis one's an interesting one, but maybe for another day.

Marisa DiNatale:            Not really. Yeah, I was more joking. Those are actual questions, but we're not going to tackle these. This is one related to inflation, and this is something that we hear about all the time. I'm going to paraphrase this question. So the question is about corporate profitability. And this has become very political in my view, from what I've seen, is blaming corporations for taking advantage of supply chain problems and keeping prices elevated, even after supply chains have eased. Right?

                                           So how much do you attribute to that? Is there any way that we can measure that? What do you think about that argument, that there are companies sort of bilking people, taking advantage of higher prices? And corollary sub-question is, as people get used to a certain price level, consumers get used to just paying more for a hotel or airline tickets or whatever, does that make prices stickier as well, just because psychologically people are sort of resetting their expectations to a different price level?

Mark Zandi:                     Chris, I've got a view, but do you want to take a crack at it?

Cris deRitis:                      Sure. So on the first one, in terms of the businesses, and is there profiteering going on or-

Mark Zandi:                     Yeah. Is the inflation because of wider margins, effectively? That's the way you might couch it.

Cris deRitis:                      Right. It comes down to monopoly power, if you can exercise that. But hard to make that argument, if it's a truly competitive market that businesses are able to... An individual business could get away with that type of inflation increase. So I think there certainly are structural issues in parts of the economy. I think you can make some of that argument, but I don't see that as the major driver of the inflation that we've been experiencing. Still quite competitive overall. So I think you can find in isolated in incidents, but I don't see that it's the corporations really taking advantage of the situation and keeping prices up or actually accelerating price growth. Yeah, that's my take.

Mark Zandi:                     Yeah, I'm in complete agreement. Chris, let's shake. Yeah, let's shake. That felt good. It felt really good that we're on the exact same page. Chris, the listener is saying, "Damn, I wish they weren't in the agreement here." But what I look at to gauge margins, is profits, total corporate profits, divided by corporate GDP or value added. That, to me, is kind of an economy-wide profit margin. And that's publicly traded companies, privately held firms, small companies, big companies, the whole shoot match. This is data from the Bureau of Economic Analysis coming out of the National Income and Product Accounts. Okay. I'm going to throw this at you. What do you think the margin was in 2019 by that measure? Total profits divided by corporate GDP? What do you think the economy wide profit margin is? This is a before tax, not after tax.

Marisa DiNatale:            40%.

Mark Zandi:                     It's a little high. 20%. Actually, 19.6%, because ironically, I just calculated this afternoon, 19.6%. Guess what it was in 2022? 19 0.6%.

Marisa DiNatale:            Really?

Mark Zandi:                     You're a little bit on the second significant digit, but no change [inaudible 01:18:07]. Now, I always getting a little nervous about how do you measure corporate profit margins. So maybe this might not be the exact right way to do it, but again, it's total corporate profits divided by basically output. You would think that that would be a good measure of margins. And they have not changed, they have not changed.

Marisa DiNatale:            And that's economy-wide across all industries?

Mark Zandi:                     Economy-wide. In aggregate.

Marisa DiNatale:            You could do it by industry too?

Mark Zandi:                     Well, I don't think, maybe-

Marisa DiNatale:            Oh, the corporate profit data isn't broken down like that.

Mark Zandi:                     Well, maybe you could, maybe you could, yeah. I take that back because you do have value added by industry and you do have profits by industry. So yeah, we could take a look at that, see what's going on. But there's a long list of reasons for the high inflation. I don't think so-called corporate profiteering is... If it's on the list, it's at the very bottom. And to Chris's point, I think you can find a case or two, you can find a company, maybe a small industry, maybe you could argue the fossil fuel industry profiteered a little bit, but that's nothing new. They just take global prices. And so when prices go up, they benefit, when they go down, they don't. So I'm not sure I'd read too much into that, but-

Cris deRitis:                      Might be some of the regional...

Mark Zandi:                     What's that?

Cris deRitis:                      There might be some regional dominance. I don't know if Adam would speak to that. So maybe a gas company that is-

Mark Zandi:                     Yeah, maybe.

Cris deRitis:                      Supplier. Right? Or something.

Mark Zandi:                     Yeah, maybe.

Adam Kamins:                 Right. The monopoly power essentially could be concentrated in a region or two.

Mark Zandi:                     Yeah. Right.

Adam Kamins:                 Yeah.

Mark Zandi:                     Yeah. Okay. Well, I think those were all very good questions. And just to the listener, please fire away. We love the questions and we'll definitely come back and try to answer as many as possible in future podcasts. Okay. I'm going to call it a podcast, unless I hear an objection to that? I know Bernard wants to keep on going. He wants to do the whole thing over again in, I think he speaks Urdu or something.

Cris deRitis:                      You have a forecast for the 76ers that we can-

Mark Zandi:                     They play tonight, man. Good game. Very good game coming up. I'm a Philly fan, and Philly fans never believe, so it's hard to believe that they're going to win. It's the curse of being a... Because they always get kind of there and then they can never quite get to the finish line. So yeah. So what about you, you got a view?

Cris deRitis:                      No, I'm totally-

Mark Zandi:                     Yeah, you're-

Marisa DiNatale:            Totally uninterested.

Mark Zandi:                     Totally uninterested. You're a bocce ball kind of guy. Yeah. All right. Very good. All right. We're going to call this a podcast. Thank you, dear listener. We'll talk to you next week. Take care now.