President Biden’s Risky Bet on the Economy III. Inflation is Proving Hard to Tame

Our biggest national problems at the present time are inflation and debt.  The annual rate of Inflation now appears to be stalled in the mid-6% range (6.5% in December and 6.4% in January) and our national debt is sitting at $31.4 trillion.  The Federal Reserve is determined to bring inflation back down to the 2% range.  Already short-term interest rates have been boosted by 4.25% and are likely to have to go up much further.  The problem is that the economy is not responding like it was expected to.  Consider:

  • The economy has been very strong in the past year.  The $5 trillion in Covid fiscal stimulus has a long tail. Years of low-interest rates have transformed debt dynamics for the overwhelming majority of U.S. households, leaving them largely shielded from the current high-interest rates.
  • The changing debt profile has allowed consumers, still cash rich from the flood of fiscal stimulus unleashed in the wake of the pandemic, to keep up their high levels of spending on services, especially as Americans have shifted away from the goods they had been buying during Covid shutdowns.
  • With over 10 million unfilled jobs in the economy, a hiring surge of 517,000 new employees in January 2023, and a very low 3.4% unemployment rate, wages are increasing rapidly.  An undersupply of housing, in combination with fresh federal investment in infrastructure, has kept the construction industry in business.
  • Some Covid spending programs, such as expanded nutrition aid, are only now winding down, while federal spending on green infrastructure initiatives, is just beginning to flow out.
  • This positive economic data has fueled hopes of a “no landing” scenario – rather than a hard or soft landing – in which the economy continues to expand. But a more realistic outlook is less benign: interest rates are likely to stay higher for longer to tamp down stubborn price growth, probably forcing at least a mild downturn along the way.
  • A no-landing scenario, in other words, is simply a delayed landing because the central bank will keep policy tight until inflation falls. And whether it will be a contractionary crash or a smooth glide back to 2% inflation remains to be seen.  Thus, even unprecedented economic strength so far isn’t enough to ensure that the Fed can avoid a painful outcome.

Conclusion.  The Federal Reserve is committed to reducing our current high rate of inflation back down to the normal 2% range.  But the Fed can’t fix inflation by itself.  It needs fiscal restraint from Congress and the President.  And it’s not getting it from the Biden Administration.  This is making the Fed’s job much harder and more likely to have painful side effects for the overall economy.

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