Democrats must avoid taking the blame for inflation
Amid deep uncertainty, how to make sense of fresh, mostly negative, economic data? Step one is to tune out the semantic debate over what constitutes a recession. Yes, according to this week’s reports, the economy shrank for the second quarter in a row. This losing streak meets the rule-of-thumb definition of a recession, but it does not accurately capture the broader economic landscape. So step two is considering the economy as a whole, also taking into account the positive news that jobs are still being created – at a robust rate of 372,000 in June – and consumer spending is increasing modestly. In other words, the U.S. economy appears to be slowing, not crashing. This slowdown was entirely foreseeable – indeed, deliberate. The sharp recovery from the steep, pandemic-induced downturn was bound to ease. More important, slower growth is the intended result of the Federal Reserve’s moves to raise interest rates and thereby tame inflation.
The Fed has its priorities right, which brings us to step three: focusing on what matters most, inflation. Friday’s inflation report showed costs up 6.8% in June relative to the year before, according to the indicator most closely tracked by the Fed, the personal consumption expenditures price index. This was the fastest inflation rate since 1982, and another dose of disturbing inflation news. Inflation eats away at savings and hurts those on fixed incomes; it destabilizes household budgets and cancels out wage increases produced by the tight labor market. Raising interest rates is the Fed’s primary inflation-fighting weapon, and until inflation is brought under control, the Fed must wield that tool. It did so again this week, raising interest rates by three-quarters of a percentage point, the fourth rate hike this year. This step was wise, even at the risk of failing to achieve the hoped-for “soft landing” of avoiding a recession.
The growth and inflation reports were greeted with no small measure of politically inspired freak-outs, no surprise in an election year. One version of election-year alarmism is the GOP’s; lacking a positive agenda, Republicans seek to blame President Biden and Democrats for an inflation-recession combo akin to the “stagflation” that undid President Jimmy Carter. Another version emanates from progressive Democrats, such as Sen. Elizabeth Warren, D-Mass., who denounced the Fed for applying higher interest rates to an inflation problem whose real origins, as she sees it, are pandemic-induced supply chain issues, the war in Ukraine and “corporate monopolies.” A “brutal” recession could ensue, she argued.
Omitted from Warren’s analysis was the impact of the $1.9 trillion American Rescue Plan in early 2021, which, as some warned at the time, unduly goosed demand amid the supply constraints she mentions. Inflation was already running well above the Fed’s target before Russian President Vladimir Putin invaded Ukraine; corporate greed, to the extent it’s a cause, is nothing new. Somewhat more plausibly, Warren touted Biden’s modest efforts to straighten out supply chains, and recommended Medicare drug price negotiation, a feature of the proposed Inflation Reduction Act. Deficit reduction in the bill, if it materializes, should help at the margins.
A real strategy to help the Fed beat inflation would go much further, however. The president should selectively eliminate tariffs on basic imports from China. Working with Congress, he should fix immigration-related bottlenecks in the labor market. Equally important is what Biden should not do: artificially fuel demand. One way to do that would be granting wholesale student loan relief, which Warren favors. Another would be cutting taxes on upper-income suburbanites by increasing the deduction for state and local taxes, as many other blue-state Democrats want. In other words, Biden’s war on inflation might require an intraparty skirmish, too.