Inflation and the 2024 Election

It’s Hurting Biden but Trump Would Make It Worse

If the polls are to be believed, most Americans are very worried about inflation –those concerns about inflation are a major reason President Biden has been getting poor marks for his management of the economy, especially among young voters and many minorities, who are an important part of the Democratic base. All this despite consistent low unemployment and a substantial rise in the stock prices since he took office. And despite the fact that inflation has come down substantially from the 9% peak a few years ago. For reasons I will explain in this post, there is a heavy irony to all this for two reasons.

First, because former President Trump, before he (involuntarily) left office in 2021, advocated the same $2000 tax rebate that President Biden quickly endorsed and helped push through Congress after he entered office – an economic stimulus that was criticized at the time by former Treasury Secretary Larry Summers for being overly generous because of its inflationary impact. While subsequent detailed economic analysis by former IMF chief economist Olivier Blanchard and former Fed Chairman Ben Bernanke has shown that the rebate was responsible for less than half of the jump in inflation (the more than other half due to the supply side disruptions associated with the pandemic), https://www.brookings.edu/wp-content/uploads/2023/04/Bernanke-Blanchard-conference-draft_5.23.23.pdf, the fact that Trump and Biden agreed on the rebate policy illustrates that inflation wouldn’t have been any lower if Trump had been reelected. In fact, because of the aggressive vaccination policies implemented by the Biden Administration, which the prior Trump administration gave no attention to after its commendable effort to get the COVID vaccine quickly through the regulatory process, Biden did more to ease the supply chain problems that were then contributing to inflation than Trump would have done.

Inflation remains a problem for Biden, however. Over the last two months, there has been too much triumphalism that inflation has been licked (that it has come down so far from its peak has surprised virtually all economists, including Larry Summers – and me!) -- so much so that the Fed was openly talking about cutting interest rates this year. No more. Inflation appears be stuck in the 3% range (although, by the Fed’s favorite measure, a little less than that), or above the pre-pandemic 2% annual target the Fed would like the economy to return to. Investors now understand that there was too much inflation optimism, which is why the stock market has taken a hit over the past week or so, and why it may move in saw-toothed jagged fashion in coming months, or maybe decline further.

If inflation doesn’t come down, or worse, inches higher, Biden will face even heavier headwinds with voters already concerned about inflation. Although quick sidebar: those same voters, in fact I suspect voters more broadly, confuse inflation, which measures the change in prices (measured by various price indices), with a one-time jump in the price level, such as one the associated with the aforementioned pandemic-era supply chain interruptions (and the energy/food price hikes in early stages of the Ukraine conflict). Nonetheless, the fact that inflation was quiescent for about two decades before 2021 set people’s expectations that inflation, again measured as the change in prices, would remain low. Against this backdrop of expectations, it is thus understandable why so many people have been traumatized by the sharp one time jump in prices in 2021-22 and will not easily put fears aside that that jump represents a harbinger of future price jumps. Or, for the Biden Administration, that too many voters won’t set those fears aside before November.

President Biden is thus in a tough spot on the campaign trail because the hard truth is that there is virtually nothing he can do about inflation between now and November.  He has said and will continue to say the Administration has cut the costs of some prescription drugs, and that tougher antitrust enforcement pursued by the FTC and DOJ should bring some prices down – though given the glacial pace at which many antitrust cases move in the courts, that process will take time. Moreover, adding up the effect of these measures, at best, will shave no more than 0.1 or 0.2 percentage points off the overall price level, not the rate of inflation.

The reality is that when it comes to fighting inflation, given the infrequency with which Congress and the President agree on large budget cuts and/or major increases, both of which dampen demand that helps fuel inflation (more about this soon), it’s all up to the Fed.  And given the long lags between interest rate changes and their ultimate economic effects, there is not much even the Fed can do about inflation now or in the next six months that it hasn’t already done.  

But having mentioned the central inflation-fighting role of Fed brings me to a second point: that President Trump could easily make inflation much worse because of the policies he may take toward the Fed. This is more than speculation. I woke up on Saturday to read on the front page of this weekend’s edition of Wall Street Journal, https://www.wsj.com/economy/central-banking/trump-allies-federal-reserve-independence-54423c2f?mod=Searchresults_pos2&page=1 (paywall protected), a lengthy article about how a team of close Trump advisers, reportedly blessed by Trump himself, are laying plans for Trump, if elected in 2024, to rein in, if not destroy, the independence of the Fed in setting monetary policy. I know this may sound like an “in the weeds issue” for the non-economists out there, but this is a REALLY BIG DEAL, especially if you care about inflation (and we’ve learned from the post-pandemic era that most Americans REALLY CARE ABOUT INFLATION).

Here's why. Any central bank needs to be largely independent of other branches of government because fighting inflation is even more unpopular than inflation itself. That’s because to fight inflation, the central bank (Fed in the US) must slow the growth of money, which inevitably leads to higher interest rates, which eventually dampen investment and certain kinds of consumption that require financing (cars, big ticket items). In turn, lower demand for goods turns into lower demand for labor, and hence rising unemployment in all previous Fed inflation-fighting episodes (we are not yet out of the woods during the current Fed anti-inflation campaign). In my lifetime, the most famous instance of the unpopularity of successful inflation-fighting was Paul Volcker’s campaign of tight money that brought double-digit inflation in the late 1970s and early 1980s down into the low single digits that we’ve experienced ever since (with the exception of t he 2021 pandemic-induced price hike). Had Volcker and his Fed colleagues not had independence, they could never have killed the inflation beast, because it was so costly in terms of unemployment, which soared for a time to roughly 10%.

Historians and economists contrast that experience with Arthur Burns’ closeness with Richard Nixon, and Burns’ goosing of the money supply before 1972, in a move widely believed to have been done to keep the US out of recession, boosting Richard Nixon’s reelection prospects. After Nixon’s reelection, inflation spiked, to be sure driven largely by OPEC’s oil embargo following the 1973 Yom Kippur in the Middle East, but certainly aided by Burns’ easy money policy.

I could go on, but I won’t. Trust me when I tell you that the economics literature is full of research showing that central independence across the world is essential for controlling inflation.

So, if you’re worried about inflation getting worse, then you should be freaked out by any move by Trump to weaken the independence of the Fed. It is common knowledge that, given his real estate career, Trump favors low interest rates. Were he directly or indirectly involved in monetary policy, there is a great risk (to put it mildly) therefore that monetary policy in another Trump administration would be too loose, risking higher inflation.

This danger is so great that I suspect that Trumps’ advisers wanted this story out to tilt the electoral prospects in Trump’s favor. Even if Trump himself has no intention on reining in the Fed, just raising the prospect that he might do so, given Trump’s reasonable chances of winning back the presidency, could easily spook investors to reduce their demand for both bonds and stocks. A drop in both bond and stock prices would have a depressing effect on the economy now and over the next few months before the election, which clearly is in Trump’s electoral interest.

In any event, there are other reasons for worrying about inflation in a Trump presidency. First, he shows little or no interest in deficit reduction, and indeed wants more tax cuts, which in an economy operating at or near full employment, would blow even larger holes in the deficit, and add to inflation. Second, he wants to impose an across the board 10% tariff on all imports, which would increase the price level and thus reported inflation in the first year (though there would be some offsetting reduction of prices generated by a temporary strengthening of the dollar that likely would follow in the wake of higher tariffs). If other countries retaliated (much as they did in the 1930s after the US imposed the infamous Smoot-Hawley tariff), and a Trump administration then responded with even higher tariffs tit-for-tat, that would generate multi-year price level increases thereafter – essentially raising the inflation rate.

As for Biden, he and his administration have wisely taken a hands-off policy toward the Powell-led Fed (Powell was appointed by Trump), even as it has ratcheted interest rates upward with the clear intent of slowing the growth of the economy, all but assuring some amount of higher unemployment. Biden is following in footsteps of most past Presidents, who realize that critiquing the Fed only backfires in the markets: investors fearing inflation only push interest rates higher. On the trade front, Biden has been much less interested in striking trade deals with our allies that would have at least a modest anti-inflationary impact. But his protectionist impulses are far less dangerous that those of Trump. And on fiscal policy, while Biden has sensibly called for higher taxes to close the deficit (though limited to upper income taxpayers), he has also proposed higher spending, limiting the deficit-reducing, and thus any anti-inflation, effect of his second-term economic plan. https://www.crfb.org/press-releases/crfb-reacts-presidents-fy-2025-budget.

In fact, neither political party shown any real interest in striking anything close to the kind of deficit reduction deal – a combination of income tax increases with social security/Medicare reforms in the future -- that the Obama administration and former Speaker John Boehner came close to sealing in 2011 but couldn’t get done.

Now the current deficit share of GDP is much higher than back then, in the 5-6% range and threatening to go even higher in the future. https://www.nytimes.com/2024/04/25/opinion/us-federal-debt.html?searchResultPosition=1 (paywall protected), which means the political pain from doing any meaningful budget deal would be much worse. Yet neither presidential candidate, or neither party, has educated the American people about what needs to be done. That fact will make it increasingly difficult for the Fed alone to control inflation in the future.

Those worried about inflation thus will not find much comfort from either Presidential candidate. Nonetheless, it is ironic that the one candidate who is most blamed for inflation thus far (inappropriately as I have argued) by voters so far, Biden, is running against the one candidate, Trump, who almost certainly would make inflation worse, potentially much worse, were he elected in 2024.