Welcome to Facing the Future, brought to you by the Concord Coalition. I'm your host, Bob Schieffer. This week we'll get an update on the economic outlook from Mark Zandi. He's chief economist at Moody's Analytics and is an influential source of economic analysis for businesses, journalists, and the public, and today on Facing the Future. Also joining the podcast and radio show is Carolyn Bordeaux, executive director of the Concord Coalition. Mark and Carolyn, welcome back to Facing the Future.
Hey Bob. Hey Carolyn. Good to be with you guys.
Good to be here. Great to have you, Mark.
Last week, Mark, we got a — we did an update on the budget outlook. We went through where the deficit and debt stood at closing in on the fiscal year — the end of the fiscal year. There wasn't a lot of good news in that show, so we thought we'd turn to the economy and see if we'd have any better luck this week on looking at the economy. So, look, we've had a number of reports come out recently on inflation, employment, GDP growth. Let me just start with the big picture. Where do you see the — we'll get into the details of these things later, but where do you see the economy right now?
Well, it's okay, I guess. You know, in aggregate, we're growing. Economists look at GDP. That's the value of all the things that we produce. And after inflation, that's growing about 2%. That's what we grew last year. That's what we have grown in the first half of this year, more or less. Which is — I'll take it. It's growth, but it's, you know, it's kind of tenuous growth in the sense that it's below the economy's potential, and, you know, the job market, while it's okay, is becoming soft, a bit soft. You can see that in wage growth. The wage growth is and continues to decelerate.
The tenuous nature also is evident in the fact that all of the growth, or the bulk of the growth, is coming from really one part of the economy, and that's artificial intelligence, AI. That goes to the capital investment, all the data center construction. That would be the poster child for that. Also, the run-up in stock prices for AI companies, that's generated a lot of wealth among the well-to-do, and they're outspending because they can. They, you know, they're a lot wealthier. So it's a kind of a very narrow basis for the growth, but that's kind of tenuous.
And the other aspect of the tenuous nature of the economy is that the benefit of the economy is really accruing to the well-to-do, the folks in the top part of the income, wealth, and consumption distribution. They, you know, the top 10, 20, maybe 25% of the distribution. The rest of the American households are, you know, they're hanging in there, but by their fingertips, and it just doesn't feel all that great. And that's why polls and surveys suggest Americans are just unhappy about their financial situation, because for the bulk of Americans, their financial situation is under a lot of pressure. So, just to summarize, you know, it's okay. You know, we're growing. It's not a recession. You know, we're moving, we're advancing, but it's a kind of a very tenuously tenuous, narrowly focused growth that's benefiting just a small, relatively small group of Americans, not all Americans.
Is that the K-shaped economy? Does that still apply?
Yeah, that's a way of describing it. The upper part of the K is the well-to-do. Their incomes and wealth are going — the AI stocks have increased. They're the ones that are spending. You know, the folks in the top 20% of the income distribution account for 80% of all the spending.
And then the bottom part of the K is everybody else. They have a job in most cases, although you don't want to lose your job because it would be very difficult to get back in because of the low rates of hiring. But most people have a job, but wage growth is decelerating. They don't own much in the way of stock, of any stock. You know, if they own a home, you know, house prices have gone nowhere the last few years. And the bottom part of the K is also the place where there's more debt. You know, people have taken on credit card debt and other sources of financing to kind of maintain their spending in the face of their kind of weak income growth and weak wage growth. So, yeah, the K-shaped economy is a pretty good apt description of, you know, what's going on.
One more question here on the economy. There was a big tax cut passed last summer, the big beautiful bill. And the theory of the case was that people would get back big refunds and spend, and the economy would be going like gangbusters right now. What went wrong with that theory, or wasn't it a good theory to begin with? Or will it happen later?
Well, I'd say the Iran war kind of got in the way. I mean, we got the tax cuts. The refund checks were larger. I think the average refund check was about 350, 400 bucks more this year compared to last year. And that's the OBBBA tax cuts. But they're now in the rearview mirror. So, that — they're done. The refunding is over, and we're still left obviously with the higher costs related to the Iran war, you know, the higher energy costs, gas and diesel, groceries, jet fuel and airline tickets, higher interest rates as a result, and of course the cost of the war itself. So, those tax cuts were opportune in their timing in the sense that they helped to offset some of the negative consequences of the Iran war, but again, the refund checks are done while the Iran war continues on and the damage continues to accumulate.
Well, just to spin out one other scenario related to the economy. Of course, here at Concord we're really interested in, you know, what the implications are for the debt and deficit. The administration has had some very optimistic growth scenarios. And one thing that people are pointing out is perhaps AI is kind of this deus ex machina coming in here saving us in terms of growth. I mean, is that something that you see in the economic numbers, and how long do you think that will continue?
Yeah, not yet. No, I don't — I haven't seen the AI boost to growth. You know, it's adding to growth, but it's not lifting growth beyond the 2% kind of where we've been. That remains to be the case. So, it's not getting like extra juice. It's just — it's basically the way I think about it is the AI is offsetting the headwinds from other things. I mentioned the Iran war, but there's the tariffs that have done a lot of damage, the immigration policy has done a lot of damage. So, you know, without AI the economy would be arguably in recession or pretty darn close. It'd feel very uncomfortable. But with the AI we're kind of hanging on, but it's not any extra juice, at least not at this point in time.
Now, that I expect to change. I do — you know, as you look out down the road, not this year, not next year, but towards the end of the decade, early next, if AI plays out in a way that is consistent with previous general-purpose technologies, we should see some lift, significant lift there, and that could help the budget situation, the fiscal situation. But I wouldn't count on that anytime soon, and I wouldn't count on it at all. I mean, a prudent planner would say, 'Okay, I'll take it if it comes.' But it's still very much a forecast, and, you know, I'd be very cautious on the forecasting given, you know, that our fiscal situation already is in a pretty significantly dark place. So, I don't know that I'd count on it, but, you know, I think there's a reasonable probability it will get a little bit more juice, but it's not here right now, and, you know, it's probably not going to be here for another year or two or three. It's going to take a little bit of time for that to play out.
The other thing I'd say is, of course, all this is highly uncertain, right? You know, it can play out in lots of different ways, and so again, I don't think a prudent planner, a prudent budgeter would kind of count on that growth to bail us out. I think we need to think about the heavy lifting here in terms of tax and spending, get our fiscal house in order, and maybe we get lucky and, you know, things play out better.
Well, just on that, one of the other things people raise is the potential for some kind of reset around the AI economy, which is a lot of debt involved, a lot of leverage in that part of the economy. We've seen a similar trajectory before, for instance, in the dot-com bubble, right? It wasn't that that didn't provide enormous growth and lift, but there was a point where it became clear that it overbuilt or people overcommitted and it reset. Are you all seeing anything like that in the future?
Well, that's another scenario, another risk near term. You know, this goes to the run-up in stock prices I was calling out before. Stock prices have risen an awful lot for AI and AI-related stocks. The hyperscalers have seen a massive run-up in valuation. I mean, just to give you a number, a statistic, the value of all publicly traded US stock has doubled in the last four years, or close to, since ChatGPT was put on the planet back in late 2022. So, doubling in four years, and all of it driven by these AI stocks. And so, you know, I think the most likely scenario is kind of assuming the stock market goes sideways here for a while and lets the reality of what's going on catch up with the stock prices.
But there is a reasonable downside scenario in the near term where one of these hyperscalers or a group stumble in the sense that they don't hit the high expectations — not that they're going to not make money, not generate revenue, but maybe not the revenue growth or the user numbers that are expected by investors. And you see a decline in price or a correction in price. And that, as you said, that's kind of sort of the MO of the internet period back in the late 90s and early 2000s. We saw the market that was a bubble, and it did crash, and it did have a significant fallout in the real economy here as well.
We're going to have to take our first break. You're listening to Facing the Future. I'm your host Bob Bixby, and I'm talking with Mark Zandi, chief economist of Moody's Analytics, and Carolyn Bordeaux, executive director of the Concord Coalition. We'll be right back after these short messages.
Welcome back to Facing the Future. I'm your host Bob Bixby, and I'm talking with Mark Zandi, Chief Economist of Moody's Analytics, and Dr. Carolyn Bordeaux, Executive Director of the Concord Coalition. Mark, I wanted to turn our attention now to inflation, which is on everybody's mind, has been for a few years. I saw something that you put out recently that let's just say inflation has been bouncing around a little bit. You know, there was a period where we thought the Fed pretty much had it under control, and then for various reasons, you can discuss it, there was a big spike last month. And then it came down a bit in June. So, people were saying, 'Great.' But the inflation number is still well above — it's over three, three and a half, and it's well above where the Fed would like it to be. But your analysis kind of traced a lot of that to two deliberate policy choices. So, where do you see the inflation picture right now?
Well, it's not good. I mean, as you point out, inflation is uncomfortably high, depending on the measure. If you use the measure the Fed uses to set its interest rate policy, the consumer expenditure deflator, inflation year-over-year is just under 4%. It's 3.5 to 4%. The target is 2. So, if we take 2 as kind of what is desirable, we're double that. So, that's not good. And I think you can trace it back to policy. I mean, the most obvious, most immediate is the Iran war. I mean, the run-up in gasoline prices, diesel prices, which feeds into groceries and everything that we get delivered at our doorstep. Jet fuel, I mentioned, and airline tickets. You know, so that's fuel — I know you're up in New England, and I'm sure the price of heating oil is on the mind. That's also up a lot as well. So, that's adding significantly to cost.
Then there is the tariffs. They've become less of a contributor to inflation because the bulk of that inflation was late last year coming early into this, but it's still playing out, still adding to the inflationary pressures. And then the other policy is immigration policy. You know, very heavy-handed immigration policy, we're seeing significant deportations, and that's creating supply shortages in lots of industries that depend on immigrant workers. You know, agriculture and construction, trade, which is really important in the South, manufacturing, transportation, leisure, hospitality, healthcare, on and on and on. So, service price inflation, which is very dependent on labor costs, is up significantly, and that goes to immigration policy.
So, if you do the counterfactual, assume that these policies were never put into place — we didn't have an Iran war, immigration policy was more normalized, we didn't have these higher tariffs — inflation would currently be pretty close to the Fed's target of 2%. So, you can make a strong case that policy is behind these high rates of inflation that we're suffering right now.
How — you know, so those don't strike me as things that are going to go away soon. I mean, it depends because they are policies, but the situation in the Middle East seems sort of a — I don't see a reversal of the immigration policies soon. So, if you're the Fed worrying about inflation, I mean, are these the sort of things that they can try to combat with interest rates, or do you really need to let the policies play out?
Well, I mean, the effect of these policies on inflation should abate. You know, the tariffs I mentioned earlier, their impacts are abating because the tariff rates are higher, but they're not rising even more, so they've stabilized. Same with the Iran war. I mean, the war can continue on and energy prices remain elevated, but as long as they don't go higher — you know, right now we're sitting at 80, 85 bucks a barrel, you know, kind of we stay there — then those effects should fade over time as well. And the immigration policy, yeah, I mean, if we continue down the path of deportations and continue to do the same thing we have been doing, that will maintain inflation, but presumably that will abate. So, you know, these things should abate.
Now, the thing from a Federal Reserve's perspective of what should the Fed do about that, because one of their, as you know, their mandates, in addition to full employment, is inflation at that 2% target, is: if I raise interest rates and weaken economic growth, you know, and give up, you know, something on my full employment mandate, is that worth the effort to get inflation back in? I think their answer is it depends on inflation expectations. If they see that — particularly in the bond market — if they see that bond investors' inflation expectations are low and anchored, then they can feel more confident that at the current rate of interest, inflation will moderate back to where they want it, back to that 2%, as these shocks, these policy shocks, fade.
However, if inflation expectations are higher, people are starting to anticipate higher rates of inflation, then they become more concerned because at that point the inflation created by these supply shocks, by these policy shocks, starts to affect wage and pricing decisions and get more embedded, and the inflation will become more persistent. The good news, at least so far, is that inflation expectations remain pretty well anchored. So, you know, if you look at that and take it at face value, the Fed should — would I — if I were on the Fed, I'd be arguing, 'Let's just keep policy unchanged. Let's not — certainly not cut, but let's not raise interest rates in the face of all this.'
They, though, may have a different calculation. In fact, it appears that they're coming around to wanting to raise rates. I mean, you saw in the last FOMC meeting, policy committee meeting, you had three dissenters. The Fed decided not to raise rates. They followed my — not my advice, but my perspective. But you had three dissenters saying we should raise rates, and there's a lot of other folks on the Fed that are kind of coming around to that. So, if you told me the next time they meet in September or in December that they raise rates, you know, I wouldn't argue with you. I'm not sure that would be what I would do, but I could easily see them coming to that decision because they don't want this inflation to become more embedded and more persistent. And they're having an increasingly difficult time looking through these shocks, these policy supply shocks.
So, you raised the issue of rising interest rates, and we at Concord — I think you were the person who said you get up every morning and you look at the yields on 10-year Treasury.
My favorite statistic. Yeah, exactly. Every morning.
And those have been going up in ways that are — also, of course, the 30-year. How do you interpret what's going on there? Is that just the Iran war? Is that tariffs? Is that kind of — is that inflation expectations? Or is it tied to the fiscal policies of the US government?
Yeah, all of the above. Yes. So, I mean, one thing we know is that the run-up in 10-year Treasury yields has been very significant since the Iran war began. So, if you go back to February, I think 27th, the day before the US launched attacks on Iran, the 10-year Treasury yield was below 4%. Last I looked this morning, we had a bit of a rally, we're at 4.65%, something like that. So, we're up 65, as they say, 65, 70 basis points, 0.7 percentage points.
So, the Iran war clearly has played a role, right? And part of that is the inflation we just talked about, which is forcing the Fed to consider raising short-term interest rates, and that's embedded in 10-year yields. Bond investors fully anticipate that the Federal Reserve is, in fact, going to raise rates, probably in September, maybe in December, maybe early next year. So, that's part of the run-up in interest rates.
The other part of the run-up in interest rates, though, is kind of a mélange of stuff. It's the so-called term premium, you know, the difference between what investors need to compensate for the risk of buying a 10-year bond versus putting their money in a 3-month Treasury bill. And that goes to, I think, in part, the new Fed chair, Chair Warsh, and his thinking around how to communicate Fed policy to the marketplace. He's got a very different perspective, a much more — you know, as you know, since Alan Greenspan to Bernanke to Yellen to Powell, the Fed had become increasingly more transparent with regard to how it was thinking about policy and signaling that to markets.
Warsh has, at least ostensibly, taken a very different perspective, and now the Fed's becoming more opaque, and the market's having a hard time digesting that, and this is creating more volatility. We have more volatility, investors want compensation for the volatility, and that means higher interest rates. So, I think, you know, Fed Chair Warsh's position on this is adding to the higher interest rates.
And then I do think the fiscal situation — you know, the amount of debt issuance, Treasury debt issuance is extraordinary to finance the budget deficits, and on top of that now you have a lot of other bond issuance by businesses that, going back to those AI companies, they are now issuing a lot of debt to finance those data centers and all that construction and all that investment building up the AI infrastructure. And that issuance combined with the Treasury issuance combined with issuance by governments all over the planet who've got similar fiscal problems, you know, big budget deficits everywhere — that's a lot of bonds for investors to digest, and to digest it they need a higher interest rate to compensate, you know, for the risk, and so that's driving up interest rates as well. So, it's not one thing, it's a bunch of things that, you know, have come together and conspired to push up rates, but rates are now high. 4.65% is, you know, on the high side of what we've seen here in the last few years and certainly since the financial crisis.
We're going to have to take another break. You're listening to Facing the Future. I'm your host Bob Bixby, and I'm talking with Mark Zandi, chief economist at Moody's Analytics, and Dr. Carolyn Bordeaux, executive director of the Concord Coalition. We'll be right back after these short messages.
Welcome back to Facing the Future. I'm your host Bob Bixby, and I'm talking with Mark Zandi, he's chief economist at Moody's Analytics. And also here with Dr. Carolyn Bordeaux. She is the executive director of the Concord Coalition. Carolyn, let me go to you for a question.
Okay. Well, we have talked about the interest rates, and of course, when we're
Looking at the federal budget, one of the real challenges the budget is facing is that those higher interest rates mean higher interest payments on the debt. We're getting ready to cross 40 trillion in terms of our gross debt. So, small jumps in interest rates actually have an enormous impact on the payments just because it's over such a huge number. Folks are starting to talk about potentially hitting a debt spiral where, you know, interest rates are greater than projected nominal growth, which means that we'll just start adding more and more — that the debt itself will grow in a sense uncontrolled even if we were to balance all of our mandatory expenditures. However, mandatory expenditures are also growing at a rate faster than our economy. So, we have this sort of really structural deficit that is growing. And so, I guess first, sort of, what are the economic impacts of that? You know, how will we experience that? How are we experiencing it now? How will we experience it going forward? And then I want to just check in with you about how you think bond markets might start pricing that in.
