The US Federal Reserve has recently been feeling the heat from unexpected quarters. Centrist Democrats have been pushing the central bank to move more aggressively toward tighter monetary policy, including interest rate hikes.
Jake Auchincloss, a Democrat from Massachusetts and member of the House of Representatives Financial Services Committee, recently told the Financial Times that “the Fed needs to start tapering immediately, and then they need to raise interest rates,” and added: “I think Chair Powell would do well to end the decade of easy money.”
It is rare that politicians call for a central bank to become more hawkish in its setting of monetary policy. We are accustomed to hearing politicians demand easier monetary conditions, lower interest rates. Easier policy is good for economic growth, better for jobs. More jobs can be translated by a politician into stronger political support. A stark example, albeit extreme, of course, was the significant pressure applied in 2019 by president Donald Trump on Fed Chairman Jerome Powell to cut interest rates.
What has changed? Inflation is back. In the past 12 months, US consumer prices have jumped by 6.8%. The Producer Price Index – in some respects, a leading indicator of consumer price inflation – has soared 9.6% in the past year. The behavior of politicians is changing because we have moved into an inflation environment that is different from what we have been in for the past 30 years.
Since 2008, consumer inflation has been around 1%-2%. It is rare that inflation exceeded 3% when looking all the way back to 1990. Today is the first time in a long while that inflation emerges as an economic problem. Moreover, it is an economic problem that has turned into a political one.
The US Fed has a dual mandate: its monetary policy goals are to foster economic conditions that achieve both stable prices and maximum sustainable employment. For many years, price stability was not an issue. There was no contradiction between the Fed’s two policy goals, and all the focus was therefore on encouraging maximum employment through easy monetary policy. But we are now in a new economic environment, in which the central bank is facing a contradiction between its goals. Fighting inflation means tighter monetary policy (higher rates), which could hurt economic activity and employment.
What is currently more pressing: fighting inflation or promoting employment? The US unemployment rate is at a fairly satisfactory level of 4.2%, approaching that which prevailed prior to March 2020, before the COVID-19 crisis began.
On the other hand, it seems that increased inflation is starting to take a meaningful toll on the political standing of President Joe Biden and the Democrats.
CNBC’s recently published All-America Economic Survey showed that inflation has now eclipsed the coronavirus as the No. 1 concern for the Americans, and that Biden’s economic approval rating dropped to a horrendous 37%, compared to 56% who disapprove. His overall approval rating is at only 41%.
These results extend to the Democrats as well: Republicans now sport a historic 10-point advantage when Americans are asked which party they prefer to control Congress, holding a 44%-34% margin over Democrats. These results imply potentially large losses for the Democrats in the November congressional election. Getting control of inflation has therefore become a major political focus – even if it means facing higher interest rates.
The writer is chief strategist, Clarity Capital.