Chief Economist @economics_ma. Host of Inside Economics podcast bit.ly/3nTDcog. Co-founder of Economy.com. Views expressed here are my own.
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The Fed’s decision to hike interest rates this past week isn’t supported by the economy’s performance. But it may make sense if the move was intended to establish the Fed’s independence under the new chair. The President has said he wants the Fed to cut rates, yet the FOMC voted unanimously to raise them.
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If so, another hike may come at the next meeting at the end of October, just days before the midterm elections. What better way to show that the Fed will not bend to pressure from the executive branch?
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That said, this puts the economy at risk. At best, it is growing at its potential and operating near full employment. Higher rates threaten to push growth below potential and place a heavy burden on an already fragile job market. Still, the near-term economic risk may be worth the long-term benefit of affirming the Fed’s independence.
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The odds of a serious Fed policy mistake are uncomfortably high and rising. Markets are all but certain the Fed will raise rates a quarter point at next week’s meeting, and are pricing in more to come. But the economy is already growing near potential (2% real GDP growth) and operating at full employment (unemployment a bit above 4%). Inflation is too high, to be sure, running above 3%. But much of that is the fallout from higher energy prices and tariffs, supply shocks that rate hikes can’t fix and that should fade on their own so long as inflation expectations stay anchored, as they have. If the Fed tightens to bring inflation down faster, it must push growth below potential, and that is hard to do without layoffs, rising unemployment, and igniting a self-reinforcing negative cycle. The challenge is even more complicated because AI-related investment appears to be powering the economy, while the non-AI economy is already struggling. To hit its inflation objective, the Fed either needs to rein in the AI boom or put even more pressure on the rest of the economy. Neither is a good outcome. Of course, it doesn’t have to choose either. It can wait.
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The wealth effect—the change in consumer spending caused by changes in household wealth—is alive and well, and it has been vital to the economy’s recent growth. The chart below makes the relationship clear. That is, when household wealth rises (falls) relative to income, saving tends to fall (rise), and spending rises (falls).
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I raise this because the wealth effect's contribution has been a topic of debate lately, including on my Inside Economics podcast, where its importance has been underappreciated. By my calculation, each $1 increase in net worth ultimately translates into approximately 3 cents of additional GDP. The surge in AI-related stock prices and household wealth since ChatGPT’s release nearly 4 years ago thus accounts for close to one-fourth of real GDP growth—both over that period and over the past year.
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AI is not responsible for all of this, but AI-related stock prices appear responsible for much of it. This is a critical point, as it highlights that the AI boom is lifting the economy to a significant extent by boosting the fortunes of the well-to-do who own the bulk of AI stocks. It also highlights the economy’s vulnerability if richly valued (frothy) AI stocks were to stumble. That is not a remote risk.
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Long-term interest rates are on the rise, and about as high as they’ve been since prior to the Global Financial Crisis. At the top of the list of reasons why is the Iran War. Prior to the war, the 10-year Treasury was below 4%. As of last Friday, the 10-year was near 4.75%. The war has fueled inflation, causing investors to shift from expecting the Fed to cut rates this year to expecting it to raise them.
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The U.S. Treasury has taken measures to stem the rise in rates, but those efforts are unlikely to work. For rates to come in, the Fed could resume quantitative easing. But barring that vexed move, oil needs to flow through the Strait of Hormuz, the Fed needs to give investors some sense of what it is thinking as it sets policy, and lawmakers need to address the nation’s darkening fiscal outlook.
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Appreciate the invite to come on the podcast — great discussion, thanks for having me.
@Markzandi Biggest Economic Warning in 35 Years
In 35 years of watching the US economy, economist Mark Zandi says he has NEVER seen a clearer sign that there’s a serious problem.
US debt-to-GDP is now around 100%.
Zandi says he can’t predict when the “day of reckoning” will come but the conditions that typically precede it are falling into place.
Full episode out now
#MarkZandi #USDebt #Economy #Recession #EconomicCrisis #DebtToGDP
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The economic angst many Americans feel has much to do with how the economic pie is being divided. From WWII to Y2K, workers received close to two-thirds of the pie, while capital received the other one-third. Since then, China’s rapid entry into the global economy, the Global Financial Crisis, the pandemic, and other forces have put labor on its heels, pushing the split closer to fifty-fifty. Measurement issues matter, and the exact shares are reasonably debated, but the direction is not. And it's not hard to imagine artificial intelligence supercharging this trend. Many Americans fear it will.
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Mark Zandi retweeted
@economics_ma Chief Economist @Markzandi says the Fed should keep rates steady through year-end. His case:
cnbc.com/video/2026/08/10/ma…
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The job market is struggling — and not just for foreign-born workers. Native-born workers are having a tough go of it, too. It wasn’t supposed to be this way, according to proponents of stiffer immigration policy. Fewer immigrant workers meant more jobs and higher wages for the native-born.
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That’s likely because many firms that lose immigrant workers know that simply offering higher wages will not necessarily attract enough native-born workers. So instead, they operate at reduced capacity: shorter hours, closed dining rooms, thinner menus, and longer lead times.
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