Why Won’t the Economy Listen to the Models?

Bloomberg’s Anna Wong on making the economic data make sense

Anna Wong is the chief U.S. economist at Bloomberg Economics. She has worked previously as a principal economist at the Federal Reserve, at the White House Council of Economic Advisers during the first Trump administration, and as Deputy Director at the Office of International Economic Analysis at U.S. Treasury during the Obama administration. She received her PhD in economics from University of Chicago. This excerpt from her interview on the American Compass Podcast has been edited for clarity.

Oren Cass: You've basically been everywhere and seen it all, in both Obama and Trump administrations, and at the Fed, and the Peterson Institute, a place that is generally thought of as uber-free-trade committed. So I'm curious for your thoughts on the distance between the actual issues and concerns economists have and what they focus on when they've been looking at the trading system versus the unanimity they present publicly about how great and wonderful it is. Is it fair to say there's a gap there? And how would you characterize what economists are worried about when they're not speaking for public consumption?

Anna Wong: The mainstream economics discourse has really shifted over the last 20 years. But 20 years ago, at the Peterson Institute, the folks there were of the older generation. They lived the 1980s, the 1970s. Fred Bergsten, for example, then Director of Peterson Institute, I remember very clearly he warned that if these global imbalances were not treated, if the IMF were to continue to be asleep at the wheel, that there would be a backlash of protectionism. And it happened exactly as he saw it, 20 years later. The civil servants and people who have worked on international monetary issues and international trade and finance, at Treasury, watching these global imbalances building, all of them would agree with that.

It is true that China has been relying excessively on external demand in the last 20 years—Germany and Europe also depending excessively on external demand to compensate for lack of domestic demand. And for 20 years, international institutions such as the IMF, with the urging of U.S. Treasury, have tried to urge these countries to increase fiscal spending and for China to increase the social security welfare system to boost domestic spending.

And for 20 years that that dial hasn't really moved. So people who have worked in this area would generally agree that there is a problem. And I think where the differences lies is in what's the solution to the problem. But the lesson from the past 20 years is clearly that there are some flaws in the multilateral institutions that are making it hard to address these issues in an effective way.

OC: With respect to Europe, on both defense and security issues and trade issues, I like to say it’s been like the adult child in the basement that isn't getting a job and is just playing video games. And the U.S. has spent the last 20 years suggesting nicely that maybe they should update their resume or maybe they should go for a job interview and they have just said, no thanks. And the Trump administration has in a sense thrown them out of the house and said, if you're not going to gradually make adjustments and make things better on your own, well then this is what’s going to happen.

And obviously we now have massive disruption. We are all now watching the data, trying to understand what is happening, trying to predict what is going to happen. What are you watching most closely? What do you think tells the clearest story about what's actually going on? What are the red herrings that people are obsessing about incorrectly?

AW: My primary audience for our work is Wall Street. I work for a financial media company, and our clients are investors and traders. What we are watching primarily is CPI data and whether this anticipated inflation due to tariffs passes through and when, if ever, is it going to arrive? We are also looking at the jobs data where I think the key question right now is whether the deterioration, if there is indeed a deterioration in the labor market, would happen faster than the inflation that people are anticipating, and how that would affect monetary policy. All of these pieces are driving financial markets right now. 

OC: And for financial markets, what they really care about is whether the Fed is going to cut rates or not—is that where the rubber meets the road? 

Because there’s so much happening in the real world right now, right? What do tariffs do to investment incentives and trade flows? What is happening to employment, especially when you factor in the potential contraction in the labor force due to immigration changes? Whether the federal funds rate goes up or down 25 or 50 basis points isn’t irrelevant, but I’m hard-pressed to believe that it’s the main driver of economic outcomes or equity values. Am I wrong? Is Wall Street wrong? Or are we somehow saying the same thing?

AW: You are not wrong. You are just much more intellectual. 

OC: That’s not always a good thing, I suppose.

AW: No, it's a great thing because those questions are questions that oftentimes Wall Street doesn’t really have the luxury to think about with their fast work pace. However, those are precisely the questions that affect things in the long term that Wall Street cares about, such as what will rates be two or five years from now? What will the unemployment rate be? What will the election outcome in 2028 be? And many investors are not day traders, who only care about the ultra-short term. You have institutional investors, particularly in pension funds, who care about three to five years ahead. And for those folks, questions like what you’re asking matter a lot.

OC: So what should these people be watching? The tariff and trade policies, and also the immigration policies, carry some short-term costs. This will be a shock to the system. An interesting analogy is what happened when Reagan came into office and Paul Volcker jacked up interest rates. You get a recession, but the results of it two, three years out are extraordinarily beneficial. And then Reagan wins the biggest re-election landslide since George Washington. So when it comes to the economy or the politics of it, I consider the three- to five-year window much more important than the one-week or one-month window. What data should we be looking at if we care about this? What should someone who wants to understand what’s going on in that timeframe find most useful? Or is it too early to have anything useful to look at?

AW: For that timeframe, I think the most important thing is the longer run impact of the resolution of the trade policy uncertainty. We’re now getting to see the shape of these trade deals and where the tariff rates are eventually settled. If tariffs eventually settle between 15 and 20%, then I think there’s a growing consensus among investors that the economy can handle it. This could be one of the reasons that the S&P 500 has kept on rallying, because people have moved past the tariffs. 

People are now fixated on the next phase: How will the investment landscape look? What we do know right now is that the resolution of the uncertainty would by itself boost investments. So there’s a one-year outlook there. Beyond that there’s incentives for firms to make the domestic investment. And I do see that in two to three years that might be favorable because there’s this cyclical rebound that you just mentioned. 

You can suppose that there’s an economic slowdown, and I think that’s indeed likely, because just the tariffs alone is essentially a one-percent contraction in fiscal impulse. Think about the $300 billion in tariff revenues that we’re getting this year. That’s about 1% of GDP. But then you have the One Big Beautiful Bill, which is an expansionary impulse, kicking in around next April. We estimate that it will be an expansionary impulse of 0.4%. And then, on top of that, you have the natural cyclical rebound from whatever happened this year. 

Heading into the midterm elections thing will start picking up on top of that. Plus, you’ll have continuing AI investment and the combination of tax incentives in the OBBB as well as the resolution of the trade war with deals and incentives in trying to get firms to invest in the U.S. This could create a tailwind not only from fiscal and trade policy but also monetary policy. It’s very likely that the Fed will be cutting more steeply next year. In fact, Wall Street already prices in that next year you’ll have all three of these tailwinds pushing the economy forward, which means that by 2027-2028, since monetary policy works with large lags, you’ll see much stronger investment.

Aside from that, investors and some really smart traders are thinking about a world where inflation is low by 2028 since AI is a very disinflationary force, and it will be very disruptive to the labor market, especially with recent college graduates. And you can already see this in China where they’re ahead in AI adoption and it’s already impacting the labor market for young people. So we may be in that spot a couple years from now, and that will be very deflationary.

There’s also immigration, where in the various models of the neutral rate, R*, population maps to neutral rate one on one. We’re expecting population growth to fall from 0.9% to 0.4% this year. This maps to a R* decrease of the same magnitude if this fall in population is sustained in the next four years. You can imagine that three to five years from now you’ll see a lower interest rate, higher productivity, and some problems with the labor market due to AI disruption.

OC: Although if we have the disruption from AI eliminating entry-level marketing and white-collar jobs exactly at the same time as a productivity boom and investment in reshoring, it could create a massive need for advanced manufacturing employment, and we might have a place where these people can work much more productively. But we will have to see.

The thing I’m struck by in that forecast is that it assumes that the tariff environment that we seem to be heading towards—in aggregate, tariffs at 15 to 20% levels—is consistent with incentives for increased investment. 

There’s a debate among economists whether tariffs in this range create positive incentives for domestic investment or if they actually discourage investment and actually encourage de-industrialization—explanations would be the increased cost of intermediate goods and inputs or some other form of friction. Do you discount that entirely? Do you think that’s also a factor? As someone who has worked with economic models and works out on Wall Street, how do you see that argument playing out?

AW: That’s an excellent question and it gets into the evolution of how the economics profession looks at trade issues. I think there’s a generation of trade economists at the Fed and in many of these international institutions who learned about trade focused on supply chains. And they’ve focused on how tariffs would disrupt supply chains and productivity, so their models are focused on that. And the tariffs could amplify these inefficiencies. 

But if you zoom back to many, many years ago, to a textbook you’ve mentioned on one of your podcasts before, Paul Samuelson mentioned that there’s a welfare-enhancing path from tariffs. And this is conditioned on foreign trading partners not retaliating. The common assumption that people make is that most likely other countries will retaliate. And what’s so strange, and what defies most people’s assumptions in their forecast that tariffs are extremely negative for the economy, is the lack of retaliation, which is part of the deal that the Trump administration is enforcing.

I thought early on that this aspect of the trade war is very different this time around from the first Trump administration. In the previous trade war, there were no conditions in the deals or clear guidance that other nations shouldn’t retaliate against us. So I think the likelihood is higher of these tariffs getting closer to that path where it’s possible to enhance welfare, and the lack of retaliation plays a key role in that.