REDBURN READS, August 24, 2023
Friends,
Jay Powell, the chairman of the Federal Reserve, is scheduled to speak tomorrow at a conference in Jackson Hole. You should be paying attention. That’s because what Powell says – and what the Fed does over the next few months tinkering with interest rates – will go a long way toward determining the winner of next year’s presidential election.
If the Fed ends up over-stepping its necessary fight against once-raging inflation and a once-overheated economy in a bid to stamp out the remaining embers, then the U.S. economy could be in a recession next year, with job losses mounting and household incomes stagnating.
If the central bank manages to curb its enthusiasm for higher interest rates – and the Chinese economy doesn’t implode – then we’re likely to continue with our slow but steady growth, sustaining low unemployment, moderate inflation, and – despite dreary polls about the state of the economy – the most prosperous time for nearly all Americans that I’ve ever experienced in my (soon!) 73 years.
I realize that there are plenty of other factors that affect a presidential election, but I’m enough of an economic determinist to believe economic conditions are the most important. Joe Biden would defeat any Republican if the economy keeps perking along. But if we’re in a recession – and Trump manages to stay out of jail next year – the consequences could be disastrous for us, our children and the fate of the Earth’s climate. For in that scenario, Trump could well become president again.
Let’s start with the challenge facing the Fed, elegantly laid out by Nick Timiraos in the Wall Street Journal:
Much of the work lowering inflation is done: Amid the most aggressive series of interest rate increases in four decades, it has fallen to 3.2% from 9.1%.
This good news presents the Federal Reserve with a new thorny question. How aggressive should it be in squeezing out what’s left?
Their decision holds major implications for consumers, the markets and the economy—and whether Fed Chair Jerome Powell achieves a so-called soft landing that beats inflation without causing a recession.
Officially, the Fed’s target for inflation is 2%. With inflation running well above that number, officials are still focused on whether to raise rates one more time this year. But that is a relatively small consideration compared with the bigger question of how long to keep rates at that high level.
Fed officials could try to get to 2% quickly, such as by the end of next year, by raising rates higher and only slowly reducing them as the economy weakens. That would risk a sharper downturn and possibly kill the chances of achieving the soft landing.
On the other hand, if they’re satisfied that inflation is slowing durably, they could hold them at their current level and consider trimming rates later next year. That would take more time to get to the inflation target—around three years.
What if getting to 2% isn’t worth the pain? Another strain of thinking says the Fed should accept a rate around 3% as the new target. Powell and other Fed officials say moving the goal posts like that isn’t an option.
Paul Krugman, not surprisingly, wants the Fed to declare victory in the war against inflation. In addition to his column for the NYT opinion pages, Krugman writes a wonkier newsletter that is must reading among economic nerds. He weighs in on the inflation-targeting issue in an illuminating take.
So if the 2 percent target was probably a mistake, and if we could do it over again, we’d probably go for 3, why not just declare victory over inflation today?
OK, I’ve been in meetings with current and former central bankers, and the reaction you get if you suggest accepting current inflation and revising the target accordingly is more or less the reaction I imagine you’d get if you waved a Pride flag at a DeSantis rally (although you’re less likely to get beaten up or shot). Why?
The main answer seems to be concerns that accepting somewhat higher inflation — even if the economics suggest that the conventional target is too low — would damage central banks’ credibility. That’s not an entirely foolish concern, although monetary credibility probably matters much less for real-world inflation than central bankers tend to imagine.
On the other hand, should policy be permanently locked into a target that now looks wrong out of fear that changing it will make policymakers look weak?
At this point I see three ways this could go:
The Fed could adopt the position attributed (dubiously) to John Maynard Keynes — “When the facts change, I change my mind” — and openly adopt a new inflation target.
The Fed could adopt a policy of strategic hypocrisy, insisting that its target hasn’t changed while in practice allowing inflation close to 3 percent for several years; then, once it has become clear that such a policy won’t allow runaway inflation, finally change the formal target.
The Fed could put its money (supply) where its mouth is and do whatever it takes to get inflation all the way back down to 2 percent, even if this involves a recession.
As far as I can tell, Option 1 just isn’t on the table. Option 2 looks like the most likely strategy. But it’s possible that the Fed will feel obliged to prove its toughness by getting back to 2 percent, even though that’s probably bad economics.
If the Fed does seem to be going that route, however, policymakers should be challenged: Should American workers really be asked to lose their jobs for someone else’s mistake?
If the Feb sustains its balancing act through next year, the American public is more likely to recognize that the overall U.S. economy (let’s stipulate that plenty of economic problems still plague our society) is doing just fine, thank you. And a critical few are, justifiably, likely to start giving Biden some of the credit for that.
Here’s Bill Scher, the unusually perceptive politial analyst, in his weekly newsletter for The Washington Monthly:
IS BIDEN STARTING TO GET CREDIT FOR THE ECONOMY?
If general election polls sampled two summers before Election Day were predictive, we would have had Presidents Walter Mondale, Bob Dole and Mitt Romney.
Yet early polls still shed light on whether news developments are impacting the electorate, or if campaign strategies are working.
So I'm less interested in the topline numbers and more interested in detecting movement in the topline numbers.
Using the FiveThirtyEight and Real Clear Politics poll repositories, I identified nine polls, unaffiliated with any presidential campaign, that surveyed registered voters about a Joe Biden vs. Donald Trump matchup, in both June and July.
In the June polls, Trump averaged a lead of 1.44. In July, Biden was up 0.44. That's a shift towards Biden of just under 2 points.
Six of the nine polls showed movement toward Biden, only two towards Trump. . .
It was one month ago when Biden delivered his "Bidenomics" speech. But as the Washington Post reported Friday, Democratic Party officials have followed up with remarkably coordinated economic messaging.
Perhaps the Democrats were reading articles in the Washington Monthly, such as:
Rob Shapiro's exhortation for Democrats to "brag more often and louder"
Felicia Wong's advice to "keep telling the story of how government helps people economically"
My analysis of how Republican messaging is out of sync with the latest data
At the moment, though, there is still a wide gap between public pessimism and the underlying data, which is remarkably good by contemporary standards.
Writing for the Bulwark – a never-Trumper outlet for moderate Republicans – Jonathan Last goes a bit overboard but is generally right about the success of Bidenomics – and, along with his guru on this subject, Noah Smith, writes very entertainingly.
2. Bidenomics Are Real
I sometimes get made fun of by my friends for being too pro-Biden. And I swear, I don’t mean to be. I’m just following the outcomes and it seems like he’s done a pretty good job and America is in okay shape. Is he the second-coming of the Rail Splitter? No. Yet compared with the presidents of my lifetime, he has to be in the top half.¹
But don’t take my word for it—here’s economist Noah Smith struggling not to praise Biden—and failing—in a post titled: “If this is a bad economy, please tell me what a good economy would look like.”
I do not want to be a shill for the Biden administration. Yes, I like most of what Biden is doing on industrial policy. But I really want to resist being one of those center-left pundits who always just blasts out the latest press release of a Democratic administration and trumpets how many jobs the President has “created”. . . .
And yet when I look at how the U.S. economy is doing right now, I find it difficult to describe it in terms that allow me to avoid sounding like a shill. I know lots of Americans still think the economy is doing poorly, and are upset about that. But when I look at objective measures, I just can’t rationalize that negative viewpoint. Because as far as I can tell from the actual numbers, this economy is doing really, really well.
This economy isn’t just good; it’s impressive
Anyway, this is all very good news. But I want to point out how improbable and surprising it is, from a macroeconomic standpoint. The basic theory of macroeconomics — still, in this day and age — includes the idea of the Phillips Curve. That means that when the government takes action to reduce inflation — raising interest rates, cutting deficits, etc. — it’s supposed to reduce real income growth and employment. There’s supposed to be a tradeoff there!
And yet instead there seems to have been no tradeoff at all. OK, maybe the Fed’s rate hikes just haven’t had time to work their way through the system yet — maybe 1.5 years isn’t enough. Maybe we’ll still eventually get that recession that everyone was forecasting up until a short while ago. But so far it looks like we’ve managed a macroeconomic miracle — bringing inflation down without damaging the real economy noticeably. . . .
This is a remarkable achievement. Who gets the credit? Because we don’t really know how macroeconomics works, we can’t actually give a definitive answer to this. Some of it was probably luck. . . .
But there’s a good argument for U.S. policy doing a lot here too. We’ll probably never know just how much the Fed’s rate hikes were responsible for taming inflation, but to think that rates can go from 0% to 5.5% with no effect would be quite an assumption. . . .
There’s also the financial side of things. Remember that a large-scale collapse of financial institutions very reliably causes economic downturns — 2008 being the most dramatic example. This could have happened in the U.S. banking system last year — rate hikes put a lot of banks in danger, and a few mid-sized regional banks like Silicon Valley Bank actually failed. But the FDIC, the Fed, and the Treasury stepped in and guaranteed bank deposits and provided emergency loans, and the banking crisis that lots of people were predicting never materialized. In fact, financial conditions in the U.S. actually improved after SVB’s collapse! . . In addition, the Biden administration might have had something to do with low oil prices. Biden released a bunch of oil from the strategic petroleum reserve back in 2022, and teamed up with Europe to put a price cap on Western purchases of Russian oil that may have allowed China and India to negotiate lower prices as well. Biden also mended fences with Venezuela and encouraged U.S. companies to start investing there again, which is starting to bring that country’s production back on line after a long hiatus. Remember that a drop in oil prices is a positive supply shock, which economic theory says should boost growth while also reducing inflation — i.e., exactly what we’ve seen over the last year or so.
And finally, there’s the investment boom. The CHIPS Act and the Inflation Reduction Act are spurring a ton of private investment in semiconductors and green energy . . .
So although I always stress that the President has a limited impact on the economy, there are several reasons — oil policy, bank rescues, and industrial policy — that I feel inclined to give Biden some credit for the economy’s surprisingly stellar performance. Not all, but some.
Don’t @ me, h8ters—send your complaints to Noah.
Why the disjunction between public attitudes and economic performance?
The political scientist Daniel Drezner, in a piece for his Substack, blames it, at least partially on the media. I don’t think it’s that simple (of course, as a former economics journalist, I would, wouldn't I?), but he has an interesting thought on how economic forecasters may be starting to take on the normally dismal view of journalists (it’s our job, after all, to point out where things go wrong) and foreign policy pundits.
I bring this up because as the summer hums along, more data is coming in showing that the U.S. economy is performing pretty well. Inflation has come down dramatically without unemployment rising, leading to a serious drop in the misery index. As noted earlier this month, it remained an open question whether the American public would update its beliefs about the state of the U.S. economy. That is due, in part, to media coverage of the economy:
Even if the economy is doing well, voters fear a downturn because that it what experts in the media are telling them. Last December Mark Zandi noted: “Every person on TV says recession. Every economist says recession. I’ve never seen anything like it.” And it’s true — never forget, last fall Bloomberg’s economics model forecast a 100 percent chance of a recession this year. 100 percent! Other surveys at the start of the year forecast a 65 percent chance of a severe global recession….
Perhaps one explanation for the post-2019 divergence between consumer attitudes and real economic performance is that beginning with the pandemic, economic forecasters absorbed the same pessimism bias as geopolitical forecasters. Hence economics reporters are covering the Biden economy the same way Politico is covering the Biden foreign policy: stressing the dark clouds that are forever on the horizon.
Finally, Brad Delong, the Berkeley economic historian, turns away from our usual worries about the American working class and has an even more fascinating theory on why many middle and upper-middle income families are so disgruntled about their economic lives. I can only quote a portion of it, but I encourage you to read the whole rambling piece.
“The country’s upper middle class isn’t used to precarity”, writes Emily Stewart, in Vox. Furthermore: “the economy’s winners feel like losers”.
In what sense could this be true?:
Emily Stewart: When the economy’s winners feel like losers: ’Part of what’s at play is the ever-increasing costs of housing and housing and housing, which have caused upper-middle-class Americans to experience housing for years. Other issues are more recent, like housing, which everybody hates. What this amounts to is people who aren’t used to financial insecurity feeling uneasier than they’re accustomed to. The bottom hasn’t fallen out for them, but the ground is less solid in a way it hasn’t been in the past. America’s semi-rich are feeling semi-bad, and they do not like it…
One can think of non-precarity as being composed of three things:
I am living almost twice as well in a material sense as my parents did.
There is no chance of the gap closing between my income and status and those who do not deserve the good things—either because (then) they did not have the right lineage and accent, or (now) they have not punched their semi-meritocratic ticket properly.
I am keeping pace with the lucky who are significantly above me in income and social power.
In the years since 1980, (1) and (3) have disappeared from the experiences of those below the top three percentiles (and when you are young a certain road from where you are into not just the top 10% but the top 3% is rarely visible). That leaves a great deal resting on (2): on being very secure against downward mobility. In the past (2) was made more secure by a tide of immigrants that put a great deal of upward pressure on the economic value of full literacy in English, and by a belief that housing was affordable when young and was bound to appreciate massively in value. Today—at least in California and in Texas and in Florida and New York—it is bilingualism that seems more likely to open doors, and getting on the housing-appreciation train that seems blocked. . .
In my view, however, the big status insult to America's upper middle-class is not the fact that incomes of upper middle-class slots in the income distribution have not doubled, but only increased by 2/3 over the past 40 years. In my view, however, the big status insult to America's upper middle class is not that those "below" them are doing "too well".
In my view, the big status insult to Americas upper middle-class is the existence of our current class of plutocrats: the top 0.01% of the income distribution hogging not the 1% of total income they had 50 years ago but instead now 5% of total income. And then there is the rest of the top 0.1%: those who hogged 2% of America’s income in the 1970s and 6% now. That means we have a top 0.01% today with 500 times average incomes compared to 100 times average incomes then. That means we have a rest-of-the-top 0.1% today with 50 times average incomes compared to 20 times average incomes then.
Thus to—relatively minor, if we are being realistic—fears about your own and your children’s economic and status future are added the obvious fact that you cannot claim that you have “made it” in any real sense, when you look at the 16000 families in the top 0.1%.
Enjoy the rest of your summer,
Tom