Focus
September 16, 2022 | 13:15
Midterm Marking
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Midterm Marking |
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The campaign for the U.S. midterm elections is heating up. On November 8, all 435 seats in the House of Representatives will be up for grabs along with 35 Senate seats. (One-third of the 100 Senate seats are contested every two years, and this is the cycle with 34 plus one special election owing to a retirement.) Midterm elections are often seen as referendums on the incumbent President and their party, with seat losses a common outcome. And, sometimes the seat losses flip party control of one or both congressional bodies. For example, in the 2018 midterms, President Trump’s Republican party lost control of the House and their federal trifecta of power (the Presidency, as well as majorities in the House and Senate) won in 2016. In the 2010 midterms under President Obama, his Democratic party also lost control of the House and their trifecta won in 2008. Obama’s second midterm elections in 2014 saw the GOP gain control of the Senate. So, with the Democrats currently holding a slim 8-seat majority in the House and control of the Senate (only because of Vice President Harris’ tie-breaking vote and the two Independents who caucus with them), their current trifecta is at risk (Table 1). |
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Some voters will be looking at the economic and fiscal policy track record of the Biden Administration and Democratic-controlled Congress in making their decisions. The U.S. economy was strong out of the 2021 gate, benefitting from reopening bounces and boosted by the fast-passed and highly stimulative American Rescue Plan Act (ARPA). Last year, three of four quarters saw real GDP growth in the 6% annualized range for a full-year average of 5.7%, the best year since 1984. Meanwhile, payroll employment averaged a monthly 562,000 gain, roughly three times the norm. Economic performance has since deteriorated, though not as dramatically as the two consecutive quarters of negative real GDP growth might suggest. For example, payrolls growth has slowed to an average of 438,000 in the first eight months of the year, while consumer spending has also downshifted. The deterioration and its likely continuation, if not acceleration, has inflation’s fingerprints all over it, through the erosion of purchasing power and the Fed’s response in raising policy rates at the most rapid pace since first targeting the fed funds rate in the 1980s. From less than 3% y/y in March 2021 (coincidentally when ARPA became law), consumer prices have accelerated, reflecting the mix of strong demand (due to pent-up spending along with massive fiscal and monetary policy stimulus) and constrained supply (due to the pandemic and Ukraine war). Inflation hit a 40-year high of 9.1% in June. Then, greased by the slide in gasoline prices from their record highs, inflation slipped to 8.3% in August. However, while the cost of filling up the gas tank has fallen, the cost of loading up the grocery cart hasn’t. Groceries inflation hit a 43-year high of 13.5% in August. Meanwhile, core CPI inflation is at 6.3%, not much improved from the four-decade high of 6.5% reached in March. America’s inflation problem is proving stubborn. |
According to Gallup, President Biden’s monthly approval rating has mirrored the move in inflation (Chart 1). His rating matched a high of 57% in April 2021, just after ARPA was signed and inflation began to accelerate (the latter was also partly due to base effects). It hit its low of 38% just after inflation peaked above 9%. And, in the wake of recent lower inflation readings, Biden’s approval rating has rebounded to a 12-month high of 44% (above where Trump stood at this point and in line with Obama). James Carville was Bill Clinton’s strategist in his successful 1992 presidential campaign. Carville’s famous quip (“It’s the economy, stupid”) is no doubt resonating with the GOP as it tries to pin the inflation donkey on the Democrats’ tail. However, political pundits are arguing that it’s not sticking as well as it could because of polarizing distractions such as Donald Trump and the overturning of Roe v. Wade. Meanwhile, despite the grandiose designs of the original Build Back Better (BBB) framework, fiscal policy ended up taking a fiscally conservative turn after the first part of the framework was passed. The BBB framework had three parts: the American Rescue Plan (ARP) for COVID-19 relief, the American Jobs Plan (AJP) for increased investment in infrastructure and climate change, and the American Families Plan (AFP) for higher outlays on healthcare, education and other social programs. The $1.8 trillion deficit-financed ARPA was signed into law in March 2021. Most of the deficit impact was front-loaded (Table 2). Then, the infrastructure part of the AJP was carved out into the separate $1.2 trillion Infrastructure Investment and Jobs Act. The IIJA was passed in a bipartisan fashion in August 2021 with a deficit price tag of $256 billion over ten years. The remaining climate portion of the AJP and the AFP were then combined into the $1.7 trillion Build Back Better bill, financed by raising taxes on corporations and high-income individuals, with a 10-year deficit impact of $367 billion. |
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The House passed the BBB bill in November 2021, but it then became bogged down in the Senate. Democratic Senators Manchin and Sinema opposed the magnitude of both the spending and tax measures. Against the background of surging inflation and rising recession risks, even other Democrats (let alone the Republicans) were becoming concerned about exacerbating the situation with large spending and tax increases. The compromise was the Inflation Reduction Act of 2022 (IRA) with its increased investments in climate change and healthcare, which were paid for (and then some) by corporate tax increases (largely via a 15% corporate minimum tax) and increased IRS vigilance. The IRA lowered the 10-year deficit by $238 billion. |
We compare the CBO’s deficit projection based on legislation passed as of January 12, 2021, before Biden was sworn in, to the most recent one based on legislation passed as of April 8, 2022, adding the CBO’s estimate of the IRA’s deficit impact to the latter (Chart 2). Much stronger-than-expected economic growth (real and nominal) resulted in ‘only’ a $517 billion deterioration in the fiscal 2021 deficit despite the size of the ARPA, with little net deficit change projected for both fiscal 2022 and 2023. And, with just one month left to go, the 2022 shortfall is running close to the $1.0 trillion estimate. Afterwards, the net increase in deficits settles into the $200-to-$350 billion range, mostly reflecting the other major change in the CBO’s economic forecast: much higher interest rates. |
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However, these figures do not include the impact of the Biden Administration’s recent student debt forgiveness plan. Estimates of the 10-year cost are huge. The Committee for a Responsible Federal Budget estimates it could run in the $440-to-$600 billion range, while the Penn Wharton Budget Model pegs it at $605 billion and possibly as high as $1 trillion. The Administration intends to ‘pay’ for this plan with deficit improvements that would otherwise have occurred. The future path for fiscal policy is contingent on the outcome of the midterm elections. Current polls suggest the GOP will gain control of the House of Representatives and the Democrats will retain control of the Senate. If the Republicans control the House, or Senate, or both, a divided government will make it much more difficult to pass legislation that involves major changes to expenditures or taxation—but not impossible, with the hefty IIJA as an example. If the Democrats keep their trifecta and manage to gain a few seats in the Senate, the door will open for potential major changes. Around the top of the agenda could be increased spending in the areas of education and affordable childcare, along with reinstating the expanded child tax credit (which was suspended in January 2022 and provided an annualized $186 billion of monthly support to families). The Democrats could also implement the global agreement on a 15% minimum corporate tax (the IRA didn’t get there). Meanwhile, the macroeconomic environment might ultimately dictate the path for fiscal policy. A possible full-flown recession would likely result in bipartisan support for another economic relief package. |