How Worried Should We Be About the Economy?

A conversation with Neil Dutta

Suddenly, everyone is pessimistic. The “Trump bump” in stocks seems like a distant memory; consumer confidence has plunged; there’s recession talk everywhere.

But is the pessimism overdone? Honestly, I don’t fully trust my own judgment here. They actually don’t teach macroeconomic forecasting in graduate school; also, partisanship is a hell of a drug, and I don’t trust myself to be immune.

So I wanted to talk to someone who assesses macroeconomic risks for a living and has a track record of not getting carried away. I’ve followed Neil Dutta of Renaissance Macro for a while, and was struck by a recent article in which he talked calmly about the reasons he sees bigger downside risks. So here’s a conversation in which we talk all about that, including some interesting arguments to the effect that we’d be facing significant headwinds even without Trump-generated uncertainty. Transcript follows.

TRANSCRIPT: Paul Krugman with Neil Dutta, recorded 3/12/25

Paul Krugman

So hi, Paul Krugman here again. For this week's video discussion, I contacted Neil Dutta from Renaissance Macro who does macro forecasting, which is forecasting the economy, which is not something I ever studied, not something I'm actually any good at. It's kind of a black art, but I've been reading his stuff over the years and it's been interesting and he had a piece that I read a couple of weeks ago about why he's starting to actually get worried about at least the possibility of a recession after having been pretty bullish on at least short-term growth all through the storm und drang of recent years. And I thought it'd be interesting to talk to him and get a professional's take. So, hi Neil. Welcome to my virtual space here.

Neil Dutta

Thank you. It's an honor to meet you and talk to you.

Paul Krugman

Yeah, so here's the thing. If you're an academic economist, you don't hardly ever worry about what the growth is going to be in the next quarter. That's not your business, even the next year. I even once long ago made fun of it as “up and down economics,” except, as it turns out, it matters a lot when it interacts with politics. And before we get into where we are now, talk to me a little bit about how you go about doing this. I mean, some people have actual models and we want to talk about that a bit, but what do you look at when you're trying to figure out what's going to happen in the near term?

Neil Dutta

Sure, so I mean, just to give you a little bit about my background, I work at Renaissance Macro Research. We're basically a macro research provider and we cover market strategy, we cover DC policy, like what pieces of legislation are moving up and down the halls of Congress, and we cover economics. So we tend to think of those sort of as like the three pillars of macro investing. And I cover the economics piece of it. So our clients range from pension funds to hedge funds, people that are doing long and short equity strategies, people that do multi-asset strategy. And what they're looking for from us isn't so much a GDP point forecast. I think that's when we talk about macro forecasting. I mean, a lot of people get tied up on, what's your GDP forecast?

I can do that, but that's not really why people come and talk to me. Why people come and talk to me, I think, is because they're trying to understand what the risks are to the consensus. So you have lots of people that kind of input their forecasts into the blue chip for a survey of consensus forecasters. Bloomberg News does want that. But what my clients are looking for isn't so much, you know, “where do you think GDP growth is going to be,” but “where are the risks to where the consensus is, and where should I invest my money given that forecast?” And so, you know, believe it or not, a lot of people live in the short run with their investments, particularly, some of our clients. I mean, there are people that live in the long run, but a lot of people don't. And that's why they're looking for some insight as to where the risks are. And so that's kind of what I do. You know, if people ask me for a GDP call, I'll give it to them. And we have simple spreadsheets that kind of tell us about where we think the economy is going. Nothing too fancy. I mean, I've been doing this now for almost 20 years. Most of the math that's used on Wall Street or business economics is sort of back of the envelope type stuff. You're not going into MATLAB and doing, like, a huge statistical analysis to get these estimates. But I think highlighting risk to consensus is basically why people talk to us.

Paul Krugman

Unfortunately, it turns out Keynes probably never actually said the market can stay irrational longer than you can stay solvent. But something like that. I mean, he kind of implied that. And it is actually true that when he said “in the long run we're all dead,” he didn't mean it actually for this situation. But nonetheless, it's true. People need to at least know what can go wrong or also what can go right, what can be different. So what are you looking at? There's official statistics, we all know, although the numbers get revised, but there's a number that comes out on the first Friday of each month, which is job growth in the previous month, and all of that. But all of that stuff tends to be, well, first of all, it's retrospective. It's more retrospective than most people realize, and it's also not telling you what comes next. So what do you look at to try and figure this out?

Neil Dutta

Well, that's a great question because I think one of the big mistakes that people make in this business, is when you get an analysis like, “never before has this indicator been this low for this long and the economy not go into recession,” right? So, for example, a big driver of the recession chatter in 2022 was the housing market. So everyone's dusting off their Ed Leamer paper, “Housing Is the Business Cycle.” They're saying, “Well, you know, if housing is going south, that means the broader economy is bound to go south as well.” We leaned against that view. But I think it's important for people to realize that these cyclical relationships aren't necessarily stable from one cycle to the next so the things that you look at in one cycle may not be the things that you look at in another cycle.

Paul Krugman

And just for listeners, cycle means business cycle, the ups and downs of the economy as opposed to the trend. We have a long history of business cycles where we can see recession and recovery dates officially that go way back into the 19th century. But the economy in 2025 is kind of different from what it was in 1875 and so historical relations may not apply.

Neil Dutta

Right, exactly. And so you asked me what I'm looking at. I very much look at the official statistics. I think those are really the gold standard. At least they are for the time being. I mean, let's hope cooler heads prevail in DC with that. But I tend to think those are the gold standard. There's no sort of private sector data point that's a substitute for the hundreds of thousands of establishments that the Bureau of Labor Statistics is surveying each month. There's nothing like it, not only for Wall Street, but really for the world. I think the US official statistics really are the gold standard. Now, you asked me what I'm looking at. And, really, I'm just using a similar playbook to what I was using back in late 2022 when I argued kind of against the consensus and said recession wasn't going to be happening in 2023. And it basically came down to a few things. Number one, it had to do with real incomes. Basically, what was going on was the labor markets weren't really slowing down, even though price inflation was, right? Because by the end of 2022, we had essentially round-tripped on energy prices and food prices. I mean, they were not rising as rapidly anymore after the Russian invasion of Ukraine. So we had a boost in real incomes.

At the same time, even though the Fed was hiking rates aggressively, if you looked at the financial markets, housing stocks were actually doing better. So we were in this strange situation where even though the resale market was frozen, home builders were in, their balance sheets had been cleaned up, they're very strong, they're doing things like buying prospective purchasers, their mortgage rates went down, they're doing rate buy downs, they're seeing activity.

So you started to see this very strange thing where housing stocks, home building stocks were outperforming. It's very unusual to see a recession with housing stocks doing well. The next thing, of course, was that the fiscal impulse was still quite strong. So we did have some growth coming from the fiscal side. And then also the way the consensus was positioned...

Paul Krugman

I'm going to interject again. “Fiscal impulses” means government spending basically minus taxes, it's the stimulus versus austerity, or whatever. And some of the Biden spending stuff was still percolating through.

Neil Dutta

Well, that and also the state and local governments were sort of sitting on a lot of their pandemic relief money. And then they went out and spent that as well. So those were sort of the three big things. And then of course, it's the way the consensus was positioned. I tend to think that recessions work through sort of an element of surprise, right? Companies think things are gonna be okay and then they're not. And that prompts a clearing out of inventories, CapEx, hiring, and then you get this negative feedback loop until policy steps in. And back then, I mean, in late 2022, well into the middle of 2023, the consensus was positioned for recession.

That was the consensus for your recession. I mean, if you're expecting a recession and it doesn't happen, then the opposite will tend to be true, right? I mean, you'll have to rebuild your inventories, spend a little bit more on hiring in CapEx and that's what was going on. So I think, yeah, 100% that's right.

Paul Krugman

Seriously. There was the infamous Bloomberg model where they gave a 100% chance of recession in late 2022, which obviously didn't age very well. But yeah, what you're saying is that GDP is almost like stock prices. If everybody knew that they were going to fall, then they would already have fallen. If everybody knew that there was a recession coming, then it would already have happened. And you're saying that the fact that it wasn't happening was kind of an upside surprise.

Neil Dutta

Well, that's exactly right. And also, I think the Fed played a role as well. I mean, there were signs that they were starting to back off a little bit, right? I mean, they weren't doing 75 basis point hikes. They were kind of dialing it back to 50, then 25, right? So you had less aggressiveness out of the Fed. So that was also helpful. Remember the recession chatter kickstarted basically when they said that pain was required to quell the inflation issue. And when they started to kind of acknowledge that maybe not as much pain was necessary anymore, the markets kind of latched onto that. But when I look at, if I apply that same kind of framework to the present, that's the piece that you're talking about, right? Which is, we know that real incomes are slowing and my reading of the data says that the labor markets are pretty frozen. The quit rates are low. Hiring, like recruiting intensity, is quite low. So you're not really seeing much in the job market. Wage growth is cooling. So as a result, you're seeing real incomes slow down somewhat. So even though the unemployment rate is low, lots of other measures suggest that maybe the unemployment rate overstates the degree of health in the job market.

Paul Krugman

There are a lot of indications that people don't feel good about the labor market even though the unemployment rate is still low. Like quit rates. People quit their jobs more when they're pretty sure they can find another one, and they're not.

Neil Dutta

Right. I think one way of describing it would be, if you have a job right now, it's probably okay for you. I mean, certainly you're not seeing the kind of wage growth we saw in the past, but it's okay. But if you're looking for one right now, it's not the best situation. One of the models I love to use is the bathtub model of unemployment, right?

Paul Krugman

Okay, I don't know that one.

Neil Dutta

Well, basically, as an example, we have the flow data with respect to unemployment, right? So we know every month how many people are transitioning from employment to unemployment, from unemployment to out of the workforce and so forth. So what the bathtub model of unemployment is telling us is it's basically likening unemployment to water in the bathtub. And we can tell, what the level of water will be in the tub based on how much water is going in and how much water is draining out. We can forecast how much water is gonna be in the tub based on those two things. And what we know about the labor market today is that layoffs remain low. So, we're not seeing layoffs increase into the labor market. But what we do know pretty clearly is that rates of job finding are down considerably. And so that's increasing, like, spells of unemployment. Like, people are unemployed for longer and that's putting slow upward pressure on the jobless plate over time. And so, based on that, I don't think we're out of the woods with respect to the unemployment rate. I know that it's kind of stabilized over the last few months, but I don't think that that's likely to continue. And Powell sort of alluded to this recently.

But because recruiting intensity is so low, because the hiring rate is so low, it wouldn't really take much in the way of layoffs to get you some pretty spooky jobs numbers. And certainly the anecdotal evidence on layoffs appears to be getting worse at the margin. I mean, we're not just talking about DOGE. We're talking about things like Starbucks laying off people, Southwest laying off people. You have a lot of bankruptcies at some major retailers. All of that is going to begin to bleed, I think, into unemployment over the next couple of months.

Paul Krugman

So, yeah. Sorry if this is too deep in the weeds for everybody, but, the federal workforce is actually much smaller than people imagine, but part of that is because of contractors. Do we know how many contracts are being canceled? How many people who are effectively being laid off by the federal government even though they aren't on the federal payroll?

Neil Dutta

We can see some evidence. If you look at Washington, DC in particular, you are seeing jobless, or unemployment claims starting to perk up. Now, obviously, for those that don't know, federal government workers have a different classification in the weekly unemployment claims data, and that number's going up as well. So, there's been an impact at least in DC. I wouldn't consider it major just yet, but it's clearly something we're monitoring. I mean, we haven't really seen much in Maryland and Virginia, sort of the areas around DC. But, it's something worth watching.

And of course, think about the buyout program that they announced. My understanding of most of the literature is that people that usually take buyouts are at or near retirement anyway. And so if that's the case, it's an open question whether those folks become unemployed after September, right? Because they may not actually be actively looking for work at that point.

Paul Krugman

And they may not be replaced, or probably won't be replaced, given the current regime. You must be reading a lot more business and corporate news than I am, but we do seem to be seeing job cuts and layoffs at big retailers and the private sector, sort of, public-facing service firms. Is that right?

Neil Dutta (18:24)

Yeah, I mean the latest data showed a pretty notable spike in layoff announcements, even excluding the government and nonprofit sector. So that's starting to happen. And as I mentioned, the level of layoffs are low. That is true. But at the same time, the level of layoffs doesn't need to go up all that much in order to get you a bad jobs number because the hiring rate is very low. So remember, it's that gap every month that really matters. We’re getting close to some pretty interesting employment reports, I think. But yeah, the anecdotal evidence is very compelling. You have companies like Southwest Airlines that never cuts their corporate staff, and they're doing that. So it's broad-based with respect to industries. You go down consumer discretionary companies, some consumer staple companies, and industrials. It's sort of across the board, you're seeing some pick up and layoffs, which I would remind everyone is sort of different than what was going on in 2022, which was very concentrated to the tech industry. Most of the layoffs that year were concentrated in tech. Now the layoffs that you're seeing are more dispersed across the economy.

Paul Krugman

I know a lot more people in sort of nonprofits than corporate, and they're definitely laying people off. They've had grants cut and they're afraid of further grant cuts, they're tightening their belts, and if that's indicative, then there's something going on here.

Neil Dutta

The higher education sector too.

Paul Krugman

Yeah. I sit on the faculty at the City University of New York and the question was put out, “Is CUNY cutting back on hiring plans?” The answer came back, “Well, we didn't actually have any hiring plans anyway.”

But a lot of this seems to be consumers, right? It feels like consumers are cutting back. I have a story about businesses possibly cutting back, but I'm not sure that you see it in the data yet.

Neil Dutta

To me, if you look at the past year, real incomes net of transfers which, to me, that's like bread and butter income, right? I mean, what are people making off wages and salaries? That's what the National Bureau of Economic Research uses when they make a recession determination, really. But real incomes net of transfers rose just 1.5% last year and consumer spending grew 3%.

Paul Krugman

So people who were going into debt were drawing on savings.

Neil Dutta

Correct. And I suppose that made some sense because we had buoyant equity prices. And maybe people were looking at crypto. I'm not sure. But generally speaking, if there was a wealth effect of some kind last year, I mean, historically when that happens, people tend to draw down their savings. There were rising asset prices and you had lower savings and that allowed people to spend way beyond their income.

Typically, as I've been doing this, my consumption forecast is usually just, “what do you think wages and salaries will do?” I don't really bake in much for the wealth effect. Historically, and if you look at the data, the equation is more or less ‘Consumption equals incomes.’ Usually. I mean, if you get the labor market trajectory right, you're more or less gonna be right about consumer spending. Didn't really work out that way last year. But I guess now you have to ask yourself, why would that wealth effect continue? And why would consumers continue to draw down their savings?

Paul Krugman

Okay, yeah.

Neil Dutta

I'm a little bit hard-pressed to come up with a reason why particularly with stocks down about 10% from their highs. Some of these alternative assets like cryptocurrency, I mean, that's gotten taken down quite a bit and even home prices are moderating right because inventories are going up in some of the major areas within the country like the South, the West, Texas, Florida…

So, the wealth effect will not be as strong. And if that's the case, I'd anticipate people are going to be more worried? And that's also true. People are a little bit more concerned. They're a little bit less confident in the jobs that they have. They're seeing that their friends are having difficulty finding new jobs. So I would suspect that that raises some precautionary saving. And if that's happening, that means that consumer spending will likely not be as strong over the next year as it's been. So, yeah.

Paul Krugman

I'm going to throw in just a personal impression that I have, which was that even last year we were still seeing a bit of revenge consumption. We were talking about revenge travel. People were still making up for the things they couldn't do during the pandemic. And I think we're probably past that now.

Neil Dutta

Well, if you look at the performance of the airline stocks in the last couple of days, it pretty much confirms what you’re talking about. I mean, the corporate story is a lot easier to tell, particularly with respect to the stuff that the administration is doing. It’s sort of the policy uncertainty literature, right? Like, if uncertainty is high, there's a tendency to delay big ticket investments because once you make that commitment, it's hard to undo. So you wanna be sort of sure before you make it. But with respect to consumer spending, it's a little more challenging. I mean, it's more difficult for me to see an obvious pattern in the data.

Paul Krugman

Is corporate investment really pulling back? I mean, we really wouldn't expect to see it in the data yet because GDP is one of those things that comes in with a lag. But do you have a sense that companies really are pulling back?

Neil Dutta

Well, if you look at the various district fed banks, they have regional surveys of their business contacts, Regional PMIs, purchasing managers, and they ask them about their six month capital spending intentions. And it's basically gone round trip. It went up right after the election and now it's coming back down again. So I think at some level, people didn't believe Trump. It's one of these things where, broadly speaking, he ran on an agenda of deregulation, tax cuts and tariffs. And I think the business community assumed that they'd get the first two and not the third, but what we're seeing is that he's leading with tariffs and we haven't really gotten much on tax legislation and the deregulatory stuff isn't really being discussed all that much. So I think there's an important signaling there that's going to, I think, lead to weaker business, non-residential business fixed investment. And of course, remember that this had been slowing going on already because we were sort of past the peak of a lot of the AI non-residential manufacturing structures, the data center build out. So we were starting to see some of that investment slow down. So now, what we're seeing coming out of DC probably does impact things like industrial equipment spending, for example. So I would expect that to show up in the data. It's already showing up in surveys of CEOs and purchasing managers. To me, everything in macro is kind of correlated. So I would suspect that things like non-defense capital goods, aircraft orders, that’s all sort of a key proxy for business investment. That probably won't be as strong as it had been in the last few months.

Paul Krugman

Again, for listeners, we have hard data, which is like your labor statistics report on employment, and we have soft data, which is like surveys where you ask executives or consumers how they're feeling or what they're doing. And the soft data have been showing weakness out there.

And it's not mostly there in the hard data, but there are lags in the hard data.

Neil Dutta

Yeah, but also, since we started the conversation on business economics and macro forecasting, generally speaking, I think the soft data helps you refine a point forecast. Like at the margin, there's information there that's useful that can help you make a better forecast of the hard data. So, for example, what are consumers telling me about the labor market? Every month the conference board has their consumer confidence survey. There’s the conference board and University of Michigan. There are differences in terms of how they probe consumers on these different questions, right? But generally speaking, I would expect consumers to tell us something useful about the labor market when you ask them, because they know when their local businesses are hiring, they know when their local businesses are shutting down, they know about the companies that are handing out pink slips, if there's been a factory opening or closing, things like that. And they'll know that before the BLS picks up on it.

There was a great New York Fed paper a few years ago talking about how consumer attitudes about current conditions tend to lead growth and perils by several months. I think it sort of makes sense.

Paul Krugman

Yeah. During COVID, when stuff was happening so fast, I learned for the first time, what does it mean to have a job number for February? It's actually a job number for the pay period, including the 12th of the month, which means that, really, you're getting sort of the first half of the previous month, not even the month as a whole. And there's been a lot of questioning about consumer surveys, partly because there's such a strong partisan element, at least in the Michigan survey. What people think about the economy is basically whether their own party is controlling the White House. But you're still saying that the consumer surveys do give you a lot of useful information.

Neil Dutta

Yeah. I think when you go into the details, I think that there's some interesting information in there. I mean, University of Michigan recently changed their methodology. I think they went more to an online sample and that's kind of messed with the data a little bit. But at any rate, when you look at some of these data points, particularly like the conference board survey, I think the information there is useful. The labor differential information is useful. I don't really detect a big partisan element there. People were saying labor market conditions were cooling before Trump assumed office, and they appear to be saying the same thing now.

Paul Krugman

Labor differential is the difference between the number of people who say that jobs are easy to find and the number of people who say that they're hard to find. And that has turned down quite a lot. The unemployment rate is basically still 4 per cent, but from people who presumably have some personal information, from their experience, that measure has definitely turned for the worse.

Neil Dutta

It has, yes. And I would just go back to the point that I made, which was: it tends to lead.

Paul Krugman

Yeah. All the uncertainty. Let me check the news from two hours ago to find out what our tariff policy is. That's got to be one contributor. And, you were saying that the AI boom was kind of not crashing but just slowing down even before they allowed the investment.

Neil Dutta

Well, there's some debate about how much more we get. It's been adding. I would say that it's been adding quite a bit to GDP growth over the last several quarters. Maybe half a percentage point when you add it all up, like data centers, non-residential manufacturing structures, IT processing equipment, software. If you add that up, you're talking about a boom not unlike what we saw in the 90s.

Paul Krugman

I've been thinking about that a lot because I've been around a while and I remember that. I remember that if you were actually looking at GDP, mean business investment back then was unusually high as a share of GDP and it turned out to be basically almost all telecoms, not dotcoms but telecoms laying in fiber. And what you’re saying is, AI has been playing a similar role, but that they've kind of either built all the capacity they think they need or are maybe even having a few doubts.

Neil Dutta

I mean, now we need to see the production pick up, right? You know, you've built out the architecture, now you need to see it in industrial production, things like semiconductor manufacturing, battery manufacturing. Some of these things have started to move higher, so that's welcome. But that's been a big driver of business investment over the last year. And so if you start to lose that at a time when uncertainty is high, basically it buckles under its own weight. If you start to lose that, let's say sometime later this year, at a time when uncertainty is still elevated, then what's the driver for growth at that point?

Paul Krugman

Because consumers are unhappy, businesses are maybe fading out. Elon Musk is chopping up the government with a chainsaw and...

Neil Dutta

Well, the federal government, that's the one that gets the most attention, obviously, in the financial press. But I do think the extent to which state and local government spending is likely to cool is sort of underappreciated.

Paul Krugman

Right. That's an interesting one. I wasn't thinking about that.

Neil Dutta

State and locals had been adding 20 to 30 basis points to GDP growth on average over the last number of quarters and that looks poised to be less of a tailwind. I mean, it could go slightly negative this year.

Paul Krugman

Yeah. By the way, people probably don't know that the federal government spends a lot of money, but most of it is transfer payments. It's money. It's Social Security checks. It's paying people's medical bills, which doesn't actually count directly towards GDP. And the stuff that does count is—defense, yes—but it’s largely state and local spending. It's employment of schoolteachers, employment of firefighters and policemen, that is part of GDP. And you say the state and local expenditures, including post-COVID relief, now they're fading out.

Neil Dutta

That's right. The Brookings Institute does very interesting work on what the fiscal impact is of federal and state and local governments. And they basically have state and local governments shifting to a drag on GDP going forward.

Paul Krugman

Okay, almost nobody saw this. In fact, I'm not sure that people see it yet. If you had asked me, I think I would have been dead wrong. If you had asked me right after the election, I'd say, “Well, look. We're heading for big tax cuts and tariffs are going to be inflationary, but probably not contractionary.” And yet, in fact, it's looking as if the big tax cuts haven't happened yet, and the tariffs are uncertain. Is your read that policy has just played out differently, or did we just all kind of think about it wrong?

Neil Dutta

Well, when I look at the markets, it feels like the markets are treating this tariff less as a stagflationary story. Like, the growth impact is what takes care of the inflation story. If you look at inflation break-even rates over the last number of weeks, they've generally been going down.

Paul Krugman

OK, again, I need to occasionally play translator. The US government offers bonds that are indexed to the consumer price index, and then it offers bonds that are not, mostly. And the spread between them is a kind of implicit forecast of inflation. And that's the break-even. And the market is actually less worried now about inflation from the tariffs, because it's more worried about a potential recession.

Neil Dutta

Right. I've had a few clients ask me, “Do you think that there's some kind of, like, 4D chess game playing where they're trying to box in the Fed to cut rates?” I mean, obviously, the risk with that approach is that recessions historically have been non-linear in nature, right? It's sort of like, once the genie's out of the bottle, it's hard to put it back in.

Paul Krugman

Yeah, once things start going down, then it tends to feed on itself.

Neil Dutta

Right, it's something that's very hard to control. So you don't want to push it too far because once you start… I mean, if you look at any chart of layoffs, for example, they look like a chart of credit spreads, and credit spreads tend to go up. It's episodic in other words, you know? And so that's why I think it's a little bit risky if that's the game that's being played here, but...

Paul Krugman

I actually have to ask: who is it that anybody thinks is playing this 4D chess?

Neil Dutta

You'd be surprised. There are a lot of people out there on Wall Street that think there's a method to the madness.

Paul Krugman

Really? I'm sorry. You know my political views, but I mean, Howard Lutnick? Who in this administration do we think is sophisticated enough to play those kinds of games?

Neil Dutta

Well, I mean, Scott Besson probably has a fairly good, or, he's got a good reputation. Obviously he's someone that got his chops breaking the bank of England with George Soros.

Paul Krugman

At least he’s not an idiot.

Neil Dutta

But at any rate, I do think that there is something. I mean, there's this view where, ‘we're gonna kind of create this growth scare, get mortgage rates down.’ But I think for the markets and for the investors, I mean, what we're basically learning is, you know, people talk about “the Fed put,” or “the Trump put.” Basically, what is the price at which you can expect some kind of policy response? And what we're learning right now is that the sort of strike price, if you will, on both of these puts is a lot lower than we thought. I mean, the fact that Trump is leading with tariffs tells you a little bit about where his head is at.

And the Fed's in wait-and-see mode. I mean, him pushing the dial up on tariffs reinforces the pivot that the Fed made in December, right? In December, they basically, fairly dramatically, changed their risk assessment around inflation. And part of the reason why was the policies that were being proposed. Some people could disagree with taking that course. You know? Sort of “just wait for the data to come to you.” But to the extent that Trump is kind of falling into that trap, it just reinforces the Fed's wait and see approach. And I think the risk is, if you have an economy that's already been slowing and a Fed that is in wait and see mode, there's a risk that they could be passively tightening monetary policy, which could kind of put additional pressure on the economy.

Paul Krugman

Passively tightening monetary policy basically means that no important real decisions are based on the Fed funds rate, which is what the Fed controls, which is an overnight rate. Actual real world spending decisions depend on much longer term rates, which are kind of the expectation of what the Fed is going to do. So if people were expecting the Fed to cut and now they don't expect it to cut, even though they haven't actually raised rates, in effect they have.

So that's what you're saying. Wow.

Unfair question: As you say, recessions tend to feed on themselves. I'm not sure it actually matters whether it's literally a recession or not, but what do you think are the odds that we're going to have a really noticeable slowdown—a rise in unemployment—sometime in the next year?

Neil Dutta

I think that's the risk. I think it's actually quite high. We talk about an actual NBER (National Bureau of Economic Research) recession. I don't think you get that, but I do think you get a situation where growth is not fast enough to keep the unemployment rate from going up. So that's kind of what I see. I think we see a continued upturn in unemployment, which is bad enough, right?

And I just keep coming back to this. Two years ago, the economy grew 3%. Last year, the economy grew 2.5%. And in both of those years, the unemployment rate rose 3.5 of 1%. So despite that strong growth, the unemployment rate was still going up. And I think if the economy slows to around one, which is kind of where I'm at over the next few quarters, like something in the ones, maybe you get additional pressure up on the jobless rate. And I think for markets, for market participants, you always see this sort of parlor game on Wall Street. Like, “My recession odds are 30%.” “No, they're 15%.” The markets will just price in the whole thing before, the markets never just stop at 30%. The markets will price in the recession and work backward if it doesn't happen.

Paul Krugman

Yeah, I've got to say, we have this weird system where what defines a recession. People think that there's some mechanical definition—like two quarters of shrinkage—but it's actually just some guys at the National Bureau of Economic Research who say that there has been a recession and it's always retrospective. And they look at a bunch of stuff. Like, the Sahm rule. There's Claudia Sahm's half point rise in the unemployment rate, which is a very good predictor of what the NBER committee will say. It sounds to me like you're saying there's a pretty good chance that we will breach the Sahm rule this year.

Neil Dutta

It's an empirical observation, right? Essentially, if the unemployment rate is half a percentage point above its prior 12 month low, then you're basically in one.

Paul Krugman

Yeah, my view has always been that the Sahm rule, although people regard it as a predictive recession, might actually be better thought of as a definition of recession.

Neil Dutta

Yes. If I'm not mistaken, the reason she came up with that was basically to, in some respects, take the politics out of countercyclical fiscal policy, right? Like, “if unemployment is up this much, the government should be stepping in and doing something to help people.”

Paul Krugman

That's right. She's been quite explicit on that. I know her personally as well. ‘This was a criteria. You don't have to wait for the NBER. You hear something. When that happens, something should happen. You should have an extra slug of government aid of some kind.’ Which is probably not what we expect from current management. But still, it's also just a really useful indicator.

I mean, you're not a catastrophe forecaster, but there are people who got a lot of credibility out of having forecast crises and people never remember the 10 other crises they called that didn’t happen.

Neil Dutta

Right. Well, I think there was a great Boston Fed paper many years ago basically making the point that forecasters that have gotten one big call right have generally been wrong about most everything else.

Paul Krugman

That's right. It's about the 10 crises they predicted that didn't happen. Those get forgotten.

Neil Dutta

Yeah, and I don't know. I think I would just like to get a lot of small calls right. That's kind of where I'm at.

Paul Krugman

Yeah, no, that's fine.

OK, this is not—I was all ready for an inflationary Trump boom and Trump pressuring the Fed not to raise rates to fight the ensuing inflation, but it's not looking like that at all right now. It may be a bit of a dilemma because of the tariffs raising prices, but at the same time, the economy is softening quite significantly.

Neil Dutta

I mean, I wouldn't call it stagflation, but, you know, it's interesting. His Treasury Secretary has been very on this idea. I mean, most people think Trump is going to pressure the Fed to cut, but Trump has said they were right not to cut last time, and they got the call right. So he's been sort of a little bit more supportive of what the Fed's done, and they're focusing more on longer term interest rates. That's kind of how they've talked about this of late. So it's less pressure on the Fed and more about trying to get longer term interest rates down. I think it's hard to separate the two to some extent because as you've always pointed out, long rates are just expectations of short rates. I mean, we'll see how long this detente lasts. I'm a little bit skeptical myself that it lasts that long, particularly if the economy starts to slow down.

Paul Krugman

Well, I don't know. I guess we'll probably get a big boost out of the extra military spending when we invade Canada. (Sorry, can't resist that sort of stuff.) But it's really interesting. I have to say that this is not at all what I was expecting. If you'd asked me what I thought would be happening right now, I thought that consumers would still be on kind of a high just because of partisanship. I thought that the stock market would still be on a high because they thought that this was a replay. Although it has come on much faster than I had imagined. But it's great to have people like you doing thoughtful analysis here. What you're saying is, you're not really pushing on the madness. We could go that way, but you're just saying that there were a lot of reasons to think that we were going to have a kind of disturbing slowdown anyway, unless we had more policy than we've gotten so far.

Neil Dutta

What I've told our clients is that uncertainty was going to be elevated. Trump has certainly added to it. But the fact that the majorities coming out of the election for the Congress were so thin to begin with, told me that it was going to be a really tough slog. And on top of that, you know, I remember eight years ago when this happened, it was pretty clear, right? I mean, there was a Paul Ryan and Mitch McConnell waiting in the wings and the whole thing was, “We will send him bills and he will sign them.” That was it. But now it's not that, right? Now the policy is coming really from his brow. And so that's a different kind of dynamic than the one that we saw eight years ago. And so I think uncertainty was going to be high. And, you know, frankly, I thought that was going to be the case regardless. I mean, whether Trump won or not. If Vice President Harris had won the election, maybe we wouldn't be facing this short run uncertainty right now that we're getting with tariffs. Who knows how long that lasts, but we would have been facing some uncertainty at the end of the year, at least for market participants, with the tax law: What's going to be extended? What's not? How high are corporate taxes? How high will they go? We would have been talking about those things towards the end of the year. I just think what's really caught people off guard is the sequencing and the signaling, right? Like, any day that he's not talking about deregulation and tax cuts is a day he's talking about tariffs, which is a day the markets will not be happy.

Paul Krugman

I think that's a good place to end this. Okay, thanks a lot.