Bidenomics and other ugly ducklings

by
Matias Vernengo
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The media and a good chunk of the policy wonks are surprised that Biden does not get the deserved recognition for the relatively good state of the US economy, and that as a result he is suffering in the polls. There are two separate, but interrelated, causes for that. The most obvious can be defined in one word, inflation. The second, is related to the fact that, even though the recovery from the pandemic was fast, the economic situation for most working class people has not been great for a long while. In other words, the recovery from the pandemic brought back a situation with which most of the people at the bottom of the income distribution were struggling. I'll deal with inflation, which is the one that everybody is discussing in the news.

Regarding inflation, two things have been negative for Biden. A lot of the mainstream (liberal) and conservative media blames Biden's fiscal package in early 2021 and, perhaps to a lesser extent, the 2022 Inflation reduction Act, for the acceleration of inflation. As do many economists connected to the Dems, more prominently Larry Summers. That view also underpins the Fed's interest rate hikes.

The interest rate hikes could have caused a recession, but now that seems to have been clearly avoided. Traditionally the mechanism is through the impact of the interest rate on residential investment, which is critical for consumption patterns. The graph below show residential investment, that fell before every recession. There were two previous false alarms, in 1951 and 1967, where the Korean and Vietnam wars, and the spending associated to those, came to the rescue. Here, it seems the extra fiscal spending which was highly criticized came to the rescue. Also, the government shutdown, which was always a possibility, and would have reduced spending (and was my biggest fear in terms of a possible recession), never materialized.

The acceleration of inflation, as I discussed several times here (see this paper and this one too, or this INET video),  was caused by supply side constraints during the pandemic, and the shocks to key prices, particularly energy and food commodities after the war in Ukraine. Since there is no significant wage resistance, it was expected that inflation would recede and fall once the shocks passed. No surprises there. And wages are winning against inflation, ad can be seen below. The wages of non-supervisory workers were growing below CPI in the early phase of the inflation acceleration, and are recovering now.

So one may very well ask why are people so angry about inflation. If one looks at the BLS resports it is clear that energy prices, early in the war, and then rents, after the Fed hiked interest rates, had higher increases than the general CPI. The graph below shows that.

This is relevant, since, for lower income people, the impact of higher energy and rental prices impact more than proportionally their ability to spend. In other words, people have less money after paying for gas and housing (and gas impacts transportation and some food items). So most people have felt the inflationary acceleration and they had to tighten the belt somewhat to maintain the same life style.

PS: The yield curve is inverted, and has been for a while and that makes some people nervous. I discussed back in 2019 why an inverted yield curve might not necessarily imply an impending disaster.