MAGGIE LAKE: Welcome to Real Vision. I'm Maggi Lake, here with Tomas Phillipson, the former chair of the Council of Economic Advisers, and the Daniel Levin Chair of Public Policy at the University of Chicago. And we are going to talk about the outlook for the US economy as we pull out of this pandemic era that we've been, or at least hope. We are trying to, Daniel, and I guess that's where we're at. We keep thinking we're coming out of this. But so far it hasn't happened. Let's start off by first characterizing where do you think the US economy is right now, as we look into 2022?

TOMAS PHILIPSON: Well, I think the economy of the last two years, that's obviously been very pandemic driven. Everything depends on is this really going to be the last wave with Omicron. It's very infectious. A lot of people now have natural immunity through this, through a milder infection. But it's two different types of forces, dependent on what happens to Omicron, or whether that subsides quickly, or whether it's lingering, or we have another strain.

MAGGIE LAKE: You're an expert in in public policy, especially health economics, I can't think of another time that medicine and disease were as critical and embedded to the health of the US economy as they are now. You can't talk about growth aspects unless you're consulting with the medical profession at the same time. What is going to be critical here, do you think to going to get the economy back on its feet?

TOMAS PHILIPSON: If you look at what happened in the last two years, economists are actually much, I'm biased obviously being an economist, but I think we have a better framework, and therefore some measure the impact of the disease on the economy, and overall, in general.

Typically, economists view is a disease like a tax. That sounds a little weird until you see the analogy. Think of a tax imposing a harm on the person paying the tax. They send in money. They don't want to send in money, particularly. But also, what a tax does is it engages a lot of people in prevention. This is the same with disease. So, if you have a tax of a million dollars on airline tickets, no one's going to fly, and there's no revenue to the government. But there's a major damage from preventing to be taxed by having to take cars all over the place.

It's the same with disease. Diseases basically attacks on activity in one way or another, particularly economic activity. What happened was, if you don't want to distract mortality and morbidity from the disease, you want to track the total form of the disease, which includes two components. One is the cost of prevention, which is where the economy come in, because the cost of prevention has been mostly foregone economic activity. Then there's the cost of the disease itself, mortality, morbidity.

If you look at when you're asked what's going to happen the next year if you look at how 2021 different from 2020. In 2020, we had enormous cost in of prevention from the disease, that is to say, activity not undertaken in the economy. It was about 80% economist estimated of the total cost and 20% being mortality, morbidity from the disease itself. That went down in 2021. Not because the disease disappeared. We are more mortality in 2021 from COVID than we did in 2020. But because all the cost of prevention are, not all, but a lot of the cost of prevention got reduced. We basically return to economic activity.

The disease went up but the total harm from the disease typically measured by economists went down. I think that's going to, not what's going to happen in 2022, if you want to look at the overall picture of those two trajectories. If Omicron is the last wave, and we've been saying this is the last wave for several waves. No, we don't know. If it is the last wave, then you will see both of them ticking down quite dramatically.

Even though we had a great GDP year this year, in 2021, last year, we will have an uptick in economic activity if Omicron turns out to be the last end of this stuff. And I think that's a natural continuation of what happened in 2020 and 2021. But I think economists have practice much better than the public health community which is only focused on disease obviously.

MAGGIE LAKE: I think that many of us hoping that this is the last, are anticipating that maybe we'll get a V shape. Like, we've come out of it. Life's back to normal. We're going to go back to normal. And we'll get the economy healed. Is it going to look like that? Or are there lingering effects that are going to be hard to shake, even if we can put the disease behind us? Is the economy going to take longer to heal?

TOMAS PHILIPSON: What has happened when I talked about the two harms of the disease, meaning prevention and the disease itself. If you look at the prevention component of that, there's two things that are happening. One is private prevention. You don't go to a party. You don't go to bars. You don't celebrate holidays with friends or family, etc. That's one form of prevention. You just minimize face to face contact with a lot of people.

The other form of prevention is the public prevention. That is to say governments are stepping in and either mandating or undertaking policies to try to prevent the damage from the disease. And that has not always been as sufficient. John Hopkins came out within meta-analysis recently, I believe it was yesterday, which show that the lockdowns have not been productive. The economist knew this, and we had date on this in early 2020. That is to say, a couple of months after the March shutdown in the US, or not shutdown, the guidance from the federal government. But that has not trickled through to the public health community.

Another form of public response is in the policy space. We had massive fiscal responses to this pandemic. If you look in 2020 and in 2021, this was the first time in a recession in 2020 that we had income growth of the population. Usually, recession is income reduction. The reason we had disposable income growth, which is both government transfers and your private income, was that the government massively increased transfers. We saw, starting with the CARES Act in 2020, all the way down through the Rescue Act in 2021, we saw an enormous fiscal response.

That made people richer from an economic negative shock, which is unusual. It never happened before in the recession. Obviously, that stimulated demand, and that led to all kinds of issues including inflation. In addition to that, the Fed obviously monetize that fiscal transfer. There were supply restrictions in the last year, not only on energy, but also a lot of other regulations that the Biden administration it's in policy.

They're far ahead of taking a first year look at different administration. They are far ahead of any other administration and what's called economically significant regulations, meaning regulations that are affecting more than 100 million in economic value. Anyways, the government response to this pandemic wasn't always the most efficient, including induced inflation through monetizing the fiscal response.

MAGGIE LAKE: It was a difficult tradeoff. So, it wasn't efficient economically, but motivated by the desire to try to keep people safe. In hindsight, we're getting a lot of data on that that might influence the next but happening in real time an experiment for everyone. When we look at that now, the shutdowns are largely over in the way that I'm assuming were the most economically damaging in here in the US. What does that mean? Let's walk through some of the areas that impact on? Is there a lasting impact, say on the labor market?

We're still seeing even Omicron making its way through some of the weekly jobless claims with payroll numbers that likely will be affected by that, would we expect to see a bounce back once we clear, or are there things that structurally changed about the labor market? We know we have massive resignations going on. We have labor shortages. We have people rethinking their priorities. We've accelerated work from home trends. Do you anticipate that some of those will return back to the way they were? Are we looking at a labor market that's fundamentally different as a result of this experience?

TOMAS PHILIPSON: Good question, Maggie. But just to address the hindsight is true. This is not in hindsight. Economist documented it in early 2020 and summer of 2020. Both that the major cost of this was not the disease and that the fiscal response made people richer during COVID than in the middle of a recession. It's viewed as a hindsight because the public health community is lagging in their understanding of the total harm of the disease, in my opinion.

But this was documented. I wrote an op-eds in early 2020. I presented the data in summer of 2020 on the fiscal response, etc. I don't think it's hindsight. People understood this in the middle of what's going on. It's just that people were paying attention more to public health authorities than they were to other people at that time. Then you had the baring thing declaration, the public health community is starting to turn.

MAGGIE LAKE: My question, I guess is if you didn't shut down and you don't know what that would have done to the public health cost if it hadn't happened, because we didn't go through it. That's just my observation.

TOMAS PHILIPSON: The common argument is that when you have a communicable disease, we have what economists call external effects that you don't take into account. They might harm others and therefore we need that the government come in and control you, essentially. Think of highways. We don't shutdown highway mortality, just because we have bad effects or bad drivers on the highway.

We try to target it better. We regulate drunk driving. We have speed limits, etc., to try to reduce that mortality, but we don't shut it down. We don't shutdown highway travel. Even though that would have been a better public health measure, fewer people would have died on the highways. But coming back to your lasting effect, which is a very, very good question. A lot of people are concerned about that.

What happened with all the labor or the leisure subsidies, whatever you want to call the welfare programs that came in, because people were not going to work. That's not only unemployment benefits, it's also food stamps, Child Tax Credit, and the direct cash payments that people got. So, many things that people usually work for, they did not have to work for in the pandemic. And that obviously discouraged people to go to work.

If you look at small businesses, the $300 or $600 checks people got for week amounts to a $7 to $15 an hour raise for their workers to compete with the government. The main competitor really think, during the pandemic for small businesses who has the government in terms of getting their labor in, or get a retaining and also hiring labor. That's a thing that doesn't take off immediately once these welfare payments go off. Because it's obviously much easier to raise wages than to cut people's wages once they started working for you.

We see a little bit of a hangover of that in the employment cost indices that came out last week, and a couple of months before that. Employers really had to compete with a much more generous government in terms of hourly pay for not working compared to hourly pay for working. And that is what you see in the cost indices going up for employment. Once the cost of employment goes up because the employment costs go up, that has to be pushed on to higher prices. So, that's part is not the entire inflation story, but it's certainly part of the inflation story that we suppress supply with these measures.

MAGGIE LAKE: I think I have the same questions about the supply chain. Will we expect things to return to normal? Or again, has this experience changed the nature of the supply chain? Or maybe shed light on things that were not working anyway, and were strained and precarious, and now we know that it's changed our behavior in terms of inventories?

TOMAS PHILIPSON: I think the private sector is going to adjust quickly. When there's money to be made, the private sector adjust and they're going to fill the goods that are needed. That's a temporary effect, in my opinion. What is not temporary is that which is interesting, which is we needed an epidemic to understand more efficient ways of interacting. For example, I think the business trips to go two hours to New York for a meeting from LA, those days are over.

The electronic communication that basically took a huge gain from that pandemic is here to stay, I think. But I'm curious that we needed a pandemic to realize the efficiency gains of interacting through video as opposed to in person. I think that's there to stay. There's also bunch of other things in terms of telemedicine is here to stay because people don't want it necessarily. Especially in the rural areas, it's here to stay because people have an hour or two to drive to the doctor, etc.

There's certain efficient aspects that the pandemic facilitated through telecommunication but the in effect efficient aspect of the bottlenecks in the supply chain with a profit driven economy, that's going to be money to be made by filling those orders, and I think that will subside with time quickly.

MAGGIE LAKE: It's interesting. You bring up the technology and the accelerated digitization that we saw, because we did see productivity numbers. The most recent batch come in stronger than expected, and they had been weak. Could we become more productive from this? And that would be a positive, wouldn't it?

TOMAS PHILIPSON: Yeah, definitely. Imagine the number of meetings you do on Zoom compared to that you couldn't do that in person. That's part of it. I don't know if there's studies or analysis out there to see how big a part of that that is. But it's certainly true that some of that telecommuting, whether for client meetings or for within firms is here to stay and some of the communication between customers and manufacturers or the telemedicine issue is also here to stay, because it's just much more productive and convenient.

MAGGIE LAKE: Do you think the US economy, are we looking to have a healthy year in 2022? Save for the prospect of unexpected new strain. But if we are able to move through this latest one, do you think that the US economy is healthy, is in a good state?

TOMAS PHILIPSON: Well, the biggest threat is obviously which everyone talks about 24/7 is inflation. The question is, what caused this inflation? And is that going to be subsiding during 2022?

Then there's three forces to operate to raise prices in 2021. The first one I already mentioned was that there was enormous demand subsidies, or people think come rose in a recession. When we came out of that and people were richer, we basically had a huge demand stimulus. Demand stimulus raises prices, typically. In addition, we had a supply suppression in 2020 with a lot of payment for not working, including unemployment, and other benefits, including food, cash payments, and Child Tax Credit, etc.

Suppressing supply raises prices. That's the part of the bottleneck issue that you don't have enough supply around, and therefore, you have increases in prices. So, two forces, demand going up, supply going down, raises prices. Economists typically talk about those price increases as relative price increases, as opposed to inflation. Inflation, we typically think of a larger money supply, but that was enabled by the Fed as a third source of this coming in and monetizing much of the debt that financed the fiscal response.

The Fed is now sitting on a $9 trillion balance sheet or 40% of GDP, which is historic as well. Those three forces basically have contributed that. The first two are more like, if we have imported goods from China, that price is going to go up because of the bottleneck, we don't call that inflation. We think of that as a relative price change, particular, relative prices went up for goods, relative to face to face services during the pandemic. But the real inflation meaning broad base price increases, we typically think of the money supply, which obviously increased dramatically with the federal response.

MAGGIE LAKE: But now we have the Fed not only talking about raising interest rates, but reducing their balance sheet. We have the prospect of less if any additional stimulus coming out of Washington. Hopefully, we will see some of those bottlenecks start to ease. Does that mean that we should see a reversal inflation? Do you think inflation is already peaked?

TOMAS PHILIPSON: There's two forces. If they start selling off their balance sheet, and if the fiscal measures stop, there's certainly downward pressure from that with interest rate hikes as well. They're responding less than interest rates typically than what historically has been done to try to fight inflation. It's usually about 200 or 300 basis points there. They have announced I think 75 basis points in 2022.

Many economists view this as a mild response relative to the 7% inflation that took place. Certainly, those are operating qualitatively in the right direction. What they're fighting is if Omicron is the last train, and we're now gone back to normal, we're going to have a heating up on the economy that counteracts that. And we'll see which one of those wins out, in my opinion.

MAGGIE LAKE: Yeah, it's all about timing, isn't it? Because things have a lag. We're going to see a lag from all that fiscal stimulus they had, but Fed policy will also have a lag. These things have to time up perfectly to get that engineer that soft landing that they're looking for. Do you think they can do that? Can we have a Fed that's raising interest rates, reducing their balance sheet at the same time, without pushing the US economy into recession?

TOMAS PHILIPSON: Yeah, this is Milton Friedman 101, or even before him. Ever since the Fed started economist, some economists have argued that there's no way you can fine tune an economy with Fed policy. First of all, they react too late to problems. When they're reacting-- usually when they're reacting, we're already in the uptake, which is certainly true now. We had a huge growth year last year. When they stop, it's too late. We're almost in a downturn when they stopped.

Some economists are very skeptical, whether 10 people in or 11 people in DC can control the economy of 330 million Americans. If they're smart enough to sit there and put on and on the controls on the economy. And I tend to be in that camp. There's other people that think that clearly, they have some power, they're not powerless. But how good are they at timing these things? That's I think it's very, very questionable.

MAGGIE LAKE: Yeah. Well, you're using blunt instruments. That's what's at their disposal.

TOMAS PHILIPSON: Well, they're also bureaucracy. Bureaucracies take a long time to respond to problems typically, and not always, but typically they do. The private market moves much quicker in responding to problems. It's often times, the bureaucracies can't keep up with the economy, and that's part of it.