America’s inflation hawks are always prone to crying wolf. Since they spent the post-2008 years forecasting hyperinflation that never arrived, it was no surprise that so few people sat up when they issued the same warnings last year. Now the hawks are right but for the wrong reasons. The recent US inflation surge has little to do with the Federal Reserve’s easy money, as they claimed. Democrats should nevertheless resist letting their ingrained scepticism cloud their sense of self-preservation. Sustained inflation could ruin their chances of holding on to power.
Historically, inflation has done far greater damage to leftwing governments than to rightwing ones, even when the blame should be evenly divided. Republican Richard Nixon did as much as his Democrat predecessor, Lyndon Baines Johnson, to stoke inflation in 1972 when he bullied the Fed chair, Arthur Burns, to cut rates in the build-up to his re-election. It was Jimmy Carter, a Democrat, who sent inflation-slayer Paul Volcker to the Fed, which contributed to Carter’s 1980 defeat. The beneficiary, Republican Ronald Reagan, tried unsuccessfully to get Volcker to cut rates in the build-up to his 1984 re-election.
President Joe Biden’s reappointment of Jay Powell last week ought to reassure markets that he values the Fed’s independence. Powell withstood pressure from the Republicans’ Donald Trump to keep rates low before the pandemic.
Yet popular wisdom — typified by Angela Merkel’s admiration for the “Swabian housewife”, suggesting balanced household budgets should be the model for national ones — will usually punish the left. In today’s case, with inflation hitting 6.2 per cent last month, America’s highest in a generation, Biden’s Democrats bear a lot of the blame. They made two errors that have come back to haunt them. The first was to pass a $1.9tn stimulus in March for which almost no economist was arguing.
Since the US output gap — that between the economy’s actual and potential output — was around $400bn, the bill was huge overkill. It meant there would be too much money chasing too few goods, which is the most common driver of inflation. The bill was also politically short-sighted since it forced Democrats to pare down the size of their far smaller but more merited “build back better” investment legislation. History might view that stimulus as a seminal Democratic mistake.
Biden’s second error was to bet that Covid-19 would fade with the vaccine rollout. Had that been the case, US consumers would have rushed out to spend their stimulus cheques on all the in-person services that were mothballed in the pandemic. But coronavirus did not vanish — partly because of the arrival of the more virulent Delta strain, but chiefly because a large minority of Americans refused to get vaccinated, or respect social distancing. Covid’s persistence meant consumers spent their expanded accounts on goods rather than services, which squeezed dollars into a narrower subset of normal consumption. Pandemic-related hits to the global supply chain did not help. But the primary culprit was the surge in demand.
As is often the case, Democrats fell victim to wishful thinking. Biden cannot be blamed for the warped defence of “freedom” that has stoked so much anti-vaxxer resistance since he took office. Protesters wearing yellow stars to liken themselves to the Jewish victims of Nazism are an example of grotesquerie with which no US president can reason. But Biden could have been far tougher on the vaccine holdouts — and still ought to be. The White House could also do a better job of explaining why high inflation is something the left should fear far more than it does.
Inflation’s frontline victims are those on fixed wages trying to save for their retirement, as well as retirees. After years of income stagnation, the US middle class ought to be enjoying the benefits of a tight labour market. But in spite of the highest wage growth in decades, inflation is even higher, which means blue-collar Americans are not feeling the upside to the recovering economy. Higher food and energy prices hit those who live from pay cheque to pay cheque the hardest. Inflation is good for debtors, which include America’s billionaire class, whose consumption is mostly funded by borrowing against unrealised capital gains. Contrary to leftwing folklore, higher inflation increases inequality, as the IMF has shown. Price stability is thus progressive.
As Biden knows, US presidents have little power to influence inflation once it is out of the bag. The temptation is to float gimmicks to make it look as if he is acting. Biden’s move last week to release 50m barrels of oil from the strategic reserve was a triumph of optics over substance. The new supply would account for just over half a day of global consumption. Oil prices actually rose on the news. Keeping Powell in place was the right step, though the Fed chair has been stretching the word “transitory” (in relation to inflation) to breaking point.
Which leaves Covid. Here is something Biden should have done already. The onset of Omicron makes it even more urgent. Obvious steps include creating a federal QR identity for the vaccinated and stopping the unvaccinated from flying. The quicker coronavirus recedes, the faster America’s service sector will return to normal. The alternative could be higher Fed funds rates than are otherwise priced in. Faced with a trade-off, Biden should embrace the vaccine culture wars with zeal.