Three Economic Scenarios for an Election Year
Following last week’s news on gross domestic product, inflation and Federal Reserve intentions, economists and Wall Street analysts are busy recalibrating their forecasts for the rest of this year. Making accurate predictions about America’s twenty-four trillion dollar economy is never easy, and the global pandemic has made it even harder. Yet, based on the new information, it is possible to identify three scenarios that could significantly impact Joe Biden’s second year in office and the outcome of the midterm elections. The first is positive, the second is mixed, and the third is potentially disastrous. The range of possible outcomes reflects how much uncertainty reigns at the moment – a malaise that has caused big swings on Wall Street.
The positive scenario, which remains the most likely, is of strong economic growth following a temporary hit from the Omicron wave, with inflation gradually receding as supply chain disruptions such as parts shortages automobiles and rising shipping costs are easing. Last week, the Commerce Department announced that real GDP – a measure of all goods and services produced by the economy, adjusted for inflation – grew at an annual rate of 6.9% last quarter of 2021, driven by strong consumer spending, healthy capital investment and businesses hoarding inventories that were depleted during the pandemic. In the first quarter of this year, GDP growth will almost certainly decline sharply as Omicron rolls across the country, but most forecasters see a healthy rebound thereafter. Last week, the International Monetary Fund, which closely monitors the global economic outlook, predicted that US GDP would grow 4% in 2022. Setting aside last year, that would be the fastest growth rate. higher since the dot-com boom. at the end of the nineties.
For all of 2021, GDP jumped 5.7%, the highest rate since 1984, when Ronald Reagan declared “Morning in America.” Real GDP is now about six hundred billion dollars higher than it was in the last three months of 2019, before the pandemic began. The recovery has been V-shaped – a sharp decline and then a sharp rise in economic activity – the result of the vigorous policy response in 2020 and 2021 from Congress and the Fed, including the American Rescue Plan Act, that Biden signed into law. last February. Why the White House didn’t hold another presidential press conference to announce the near-record GDP figure is beyond me. If Donald Trump had still been in office, he would have hung a banner saying “Morning in America Again” above the north portico.
Midterm, a second year of strong GDP and job growth would give Democrats a strong record to campaign on. But the Party also needs inflation to fall to 7%, the highest level since the early 1980s. In a YouGov opinion poll released last week, 46% of respondents said inflation was now the most important issue facing the US economy. Only 10% cite unemployment. In the optimistic scenario presented by the IMF, strong GDP growth and lower inflation could indeed coexist. As the year progresses, “supply and demand imbalances” are expected to fade, energy and food price increases are expected to moderate, and inflation is expected to “calm down in 2023,” predicted Gita Gopinath, the IMF’s first deputy managing director. blog post. For the president and the Democrats, obviously, the faster the sag, the better.
In the mixed scenario, the economy would continue to grow at a healthy pace and the unemployment rate would continue to fall, but the inflation rate would remain at a politically damaging high level. That would leave Biden and the Democrats pretty much where they are now. On Jan. 28, the Commerce Department reported that in the twelve months to December, the Personal Consumption Expenditures Price Index, a measure of inflation the Fed closely monitors, rose 5.8 percent, its biggest jump since 1982. Over the same period, the employment cost index, which includes wages and benefits, rose 4 percent, the Labor Department said. These reports confirmed that while some low-wage workers have seen wage increases above inflation, wage gains for most Americans have not kept up with rising prices. Polling data suggests that many voters hold Biden at least partially responsible.
Based on recent developments, an immediate reversal in the level of inflation seems unlikely. Shortages of industrial components, such as semiconductor chips, persist. The same goes for grunts at major ports of entry, including Los Angeles and Long Beach. These snafus continue to drive prices up. With the shortage of new cars, the average price of used vehicles hit a new high of $28,205 in December, according to research firm Cox Automotive, from $22,087 twelve months earlier. McDonald’s expects the cost of its food and paper inputs to rise 8% this year. Kraft told supermarkets that in March it would raise prices on dozens of products, including deli meats, hot dogs, coffee and cheese, CNN reported. The price of a three-pack of Oscar Mayer turkey bacon will increase by thirty percent.
Such developments explain the hawkish comments made by Jerome Powell, the chairman of the Fed, during a press conference on January 26. Wall Street was already expecting the Fed to start raising interest rates at its next policy meeting in March, but Powell’s tone surprised investors. In the past, the Fed has tried to space out its rate hikes. But Powell adamantly refused to rule out successive rate hikes or an individual half-percent rate hike, rather than the usual quarter-percent move. After analyzing Powell’s remarks, Goldman Sachs predicted that the Fed would hike rates five times this year. “No more Mr Nice Guy,” wrote Michael Feroli, chief US economist at JPMorgan.
The danger of the Fed’s hawkish turn is that it could inadvertently end up crashing the stock market, sinking the housing market and killing the economic recovery: that’s the politically dire scenario for Democrats. Obviously, Powell and his colleagues have no intention of causing such an outcome; they are trying to stage what Fed watchers call a “soft landing” for the economy. Two of his three predecessors, Alan Greenspan and Ben Bernanke, failed to achieve this feat. If inflationary pressures were to build – perhaps due to Omicron-related shutdowns in China, further exacerbating supply problems, or a Russian invasion of Ukraine, causing the price of oil to spike again – Powell and Fed policymakers may feel compelled to keep raising rates even in the face of a weakening economy. It would be a big political mistake, but central banks, including the Fed, have already made big mistakes. And Biden, not Powell, could be shot at the ballot box for it.
Much depends on salary increases in the coming months. At his press conference, Powell said the Fed is concerned about the risk of “persistent real wage growth outpacing productivity,” which could lead to a wage-price spiral that would entrench higher inflation. Over the weekend, I spoke with two forecasters who have always argued that inflation should slow. Ian Shepherdson, chief economist at Pantheon Macroeconomics, pointed out that the employment cost index rose less in the fourth quarter of 2021 than in the third quarter. Shepherdson said he was pleasantly surprised by the decline, which he described in a note to clients as “a big step in the right direction”. He predicts that inflation, as measured by the consumer price index, will peak at 7.3% in February, fall to 6.4% in April and fall below 4% in October. At the same time, Shepherdson sees GDP rising 3.5% this year and the unemployment rate also falling to 3.5%.
When I spoke with Greg Daco, EY-Parthenon’s chief economist, on January 29, he said the recent surge in oil prices prompted him to change his forecast of when inflation would peak. , from February to March or April. “But I would still expect the numbers to go down over the course of the year,” he added. “Inflation numbers will go down.” For Biden and the Democrats, a lot hinges on the accuracy of this prediction.