The writer is president of Queens’ College, Cambridge and an adviser to Allianz and Gramercy
Looking at the prospects for the economy and markets in the run-up to the November 2022 midterm US elections, I have an unsettling feeling that I may end up watching the repeat of a script from just over a decade ago.
A transformational agenda for the US economy is again at risk, as questions also mount for financial markets. Fortunately, there is still time to change the storyline but it’s getting late day in the day. Moreover, the most important and needed policy adjustments lie outside the direct control of the Biden administration.
Like Barack Obama back in 2008, President Joe Biden came into the White House with ambitious economic policy proposals. If implemented fully, they would help unleash growth that is not just high and durable but also a lot more inclusive and sustainable.
But similar to Obama, Biden’s ability to follow through on these policies is subject to the Democrats’ ability to maintain control of Congress. And just like Obama, the prospects for this goal at the first set of midterm elections in a year’s time is threatened by a misreading of the economic recovery process.
Obama’s ability to purse his economic agenda, including a set of jobs-related measures that would have enhanced both productivity and labour force participation, was severely and prematurely curtailed by a midterm election “shellacking” that quickly polarised and paralysed Congress
Underpinning this outcome was a misreading of the economic situation. It took too long for Obama’s economic team to realise that, rather than a very sharp cyclical shock, the 2008 financial crisis had exposed deep structural weaknesses that had been years in the making and required sustained policy attention. This was a secular rather than a cyclical moment for the economy.
Two of the three “T’s” principles guiding policies at the time (“timely” and “targeted”) were well framed and absolutely correct. The third, “temporary”, turned out to be inconsistent with the needed emphasis on longer-term efforts to boost inclusive growth.
Rather than just one big bang of policies to accelerate a cyclical recovery, what was needed was a sustained structural effort to improve the functioning of many parts of the economy. Absent that, the sense of economic alienation and marginalisation of certain segments of the population grew, turning an important part of the electorate against the Democrats.
The problem was not the qualification and experience of the economic team. Rather, it was mindsets that, unconsciously, had become hostage to an economic landscape that had been upended by both the run-up to the financial crisis and its aftermath.
As such, it took time to recognise that rather than the economy going through a deep V-shaped contraction and recovery, it was facing a “new normal” of excessively low and unequal growth — or what was later characterised as “secular stagnation”.
Biden’s Democratic party risks following the same trajectory if economic officials, and the Federal Reserve in particular, do not quickly pivot to a more open mindset about the economy’s inflationary process and required policy adaptations.
As I have argued for months, here and elsewhere, the Fed has consistently and repeatedly mischaracterised inflation as “transitory”.
Captive to the wrong mindset, it is also now hostage to a “new monetary framework” designed for the old world of deficient aggregate demand and not the current reality of supply bottlenecks and labour shortages. As a result, the Fed has missed some important policy windows to reduce the risk of unanchored inflationary expectations.
The persistence of high inflation would hit the poor particularly hard and undermine economic recovery, both unnecessarily so. It also creates harmful headwinds for the continued implementation of the Biden administration’s economic agenda while also potentially complicating the much-needed general pivot in favour of climate-friendly investments.
It is hoped that this week’s revamp of the leadership team at the Fed will provide the central bank with an opportunity to reframe its public assessment of the inflation challenge facing the economy and, with that, pivot quickly as a first step to a meaningful acceleration in the taper of its massive financial asset purchases.
Without that, America faces a new risk of delaying yet again policies that enhance both current and future economic wellbeing.