President Joe Biden and Democrats will likely be dealing with the fallout from high inflation throughout the year, a prospect that bodes poorly for Democratic prospects in the midterm elections.
Inflation has soared. Consumer prices grew 7% in the 12 months ending in December, the fastest pace since 1982. Because of the inflation, the Federal Reserve is gearing up to hike interest rates several times this year and appears on track to be even more hawkish in its 2022 monetary policy than was thought even just weeks ago.
The high inflation has provided Republicans the opportunity to bash Democrats for spending so much during Biden’s first term.
STOCKS PLUMMET AS FED GEARS UP TO RAISE INTEREST RATES FOR FIRST TIME IN YEARS
But even if the rate hikes succeed in driving down prices before November, the administration might have to deal with the deleterious economic effects that rising rates bring in the run-up to the election.
Desmond Lachman, a senior fellow at the American Enterprise Institute, noted that the mere mention of increased interest rates can spook the markets. He said the administration is facing two problems: The first is that inflation is running too hot, and the second is that there are bubbles destined to burst that have been fed by interest rates being so low for so long.
Regarding the housing market, Lachman said even adjusting for inflation, prices are higher than they were at the peak of the housing bubble in 2006.
The Fed can’t keep interest rates at their current level because inflation is so high, but when the central bank starts hiking those rates, housing prices and the prices of other assets could tumble, he argued.
“So if the Fed doesn’t raise the interest rates, then we’re going to have an inflation problem, but if the Fed raises the interest rates, we might not have an inflation problem — but then we’ve got a recession,” Lachman told the Washington Examiner.
The prospect of either sticky inflation or a noticeable economic downturn is not a favorable prospect for Democrats, who have been polling below Republicans and hold only slim margins in the House and Senate.
According to the Fed itself, the notion of rising interest rates causing a major economic downturn is not likely.
The central bank projected after its December meeting that while inflation is hitting multi-decade highs right now, inflation, as measured by the Personal Consumption Expenditures Price Index, will tamp down to between 2% and 3.2% this year. Federal Open Market Committee participants signaled the likelihood of three interest rate hikes this year, although Fed watchers have recently been expecting even more rate hikes for 2022.
The December projection showed that while the committee participants anticipate gross domestic product growth to slow to 4%, they also predict that the unemployment rate, now sitting at 3.9%, to fall to 3.5% by year’s end — the same ultralow level it was at prior to the start of the pandemic.
Still, Fed projections have been notoriously mercurial over the past year, with the central bank turning out to be wrong about just how bad inflation would get.
David Sacco, a practitioner in residence at the University of New Haven finance department, said the Fed appears to have become much more concerned about inflation and how to manage it in recent weeks. He said the tone at the Fed from Powell and officials has “completely changed.”
“What that tells me is that from their perspective, they’re starting to get really worried about inflation,” Sacco told the Washington Examiner.
That sense of concern has led investors to believe that the Fed will end up increasing interest rates more than three times. Jamie Dimon, the chairman and CEO of JPMorgan Chase, said this month that he would be “surprised” if the Fed only hikes interest rates four times, although he remains optimistic about the state of the 2022 economy.
“We’re going to have the best growth we’ve ever had this year — I think since maybe sometime after the Great Depression,” Dimon told CNBC. “Next year will be pretty good too.”
The Fed will have to be careful in the coming months when it tries to thread the needle of tamping down inflation without damaging the economy, which has the potential to lead to unemployment and other economic malaise.
“The question is that if inflation is going down by November, but unemployment is going up and the stock market is going down, is that a good or bad economic situation?” Sacco remarked.
No matter what is going on economically in November, Republicans are going to inevitably portray any negatives as the fault of Democrats and something that can be remedied if they take back the House and Senate.
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Gallup polling found that in the first quarter of last year, nearly 50% of U.S. adults identified as Democrats or leaned more toward the Democratic Party and 40% said the same for Republicans. But by the end of last year, just 42% of adults said they identified or leaned toward Democrats, while 47% identified with or leaned toward the Republican Party.
The 2022 midterm elections are set for Nov. 8.
