Unless the Fed is aware of inflation, the Obama era’s “shelling” is imminent

The author is the president of Queen’s College, Cambridge University and an advisor to Allianz and Gramercy

Looking at the economic and market prospects before the mid-term elections in the United States in November 2022, I have a sense of anxiety. I may finally see a replay of the script more than ten years ago.

The transformation agenda of the U.S. economy is once again at risk because of the increasing number of problems in the financial market. Fortunately, there is still time to change the storyline, but it is already very late. In addition, the most important and most needed policy adjustments are not within the direct control of the Biden administration.

Like Barack Obama in 2008, President Joe Biden entered the White House with ambitious economic policy proposals. If fully implemented, they will help unleash not only high and sustained growth, but also more inclusive and sustainable growth.

But similar to Obama, Biden’s ability to implement these policies depends on the Democratic Party’s ability to maintain control of Congress. Just like Obama, the prospect of achieving this goal in the first midterm elections a year later is threatened by a misunderstanding of the economic recovery process.

Obama’s ability to pursue his economic agenda, including a series of employment-related measures that can increase productivity and labor participation, was severely and prematurely weakened by the “retreat” of the midterm elections, which quickly polarized and paralyzed Congress.

Supporting this result is a misunderstanding of the economic situation. It took a long time for Obama’s economic team to realize that the 2008 financial crisis did not bring about very severe cyclical shocks, but exposed deep structural weaknesses that had formed over the years, which required continuous policy attention. For the economy, this is a long-term rather than cyclical moment.

At that time, two of the three “T” principles (“timely” and “targeted”) guiding policies were well structured and absolutely correct. The third is “temporary,” which turned out to be inconsistent with the necessary emphasis on long-term efforts to promote inclusive growth.

What is needed is not only a large wave of policies to accelerate the cyclical recovery, but also continuous structural efforts to improve the operation of many parts of the economy. Without this, the economic alienation and marginalization of certain population groups will increase, thus becoming an important part of voters and opposing the Democratic Party.

The problem is not the qualifications and experience of the economic team. On the contrary, it is the mentality that has unknowingly become the hostage of the economic structure, which has been subverted by the precursors and consequences of the financial crisis.

Therefore, people need time to realize that the economy is not experiencing a deep V-shaped contraction and recovery, but facing a “new normal” of undergrowth and inequality—or later described as “Long stagnation”.

If economic officials, especially the Fed, do not quickly turn to a more open mind about the economy’s inflation process and required policy adjustments, Biden’s Democrats may be on the same track.

As I argued here and elsewhere for months, the Fed has consistently and repeatedly incorrectly described inflation as “temporary.”

Subject to the wrong mentality, it is now also subject to the “new currency framework” designed for the old world with insufficient aggregate demand, rather than the current reality of supply bottlenecks and labor shortages. Therefore, the Fed missed some important policy windows to reduce the risk of unanchored inflation expectations.

The persistence of high inflation will deal a particularly severe blow to the poor and undermine the economic recovery, both of which are unnecessary. It also creates unfavorable resistance to the continued implementation of the Biden administration’s economic agenda, and may also complicate the much-needed overall shift in favor of climate-friendly investment.

Hope this week Retrofit The members of the Fed’s leadership team will give the central bank an opportunity to re-adjust its public assessment of the inflation challenge facing the economy and use this as the first step to meaningfully accelerate its large-scale financial asset reduction.

Without this, the United States will face a new risk of postponing again policies that improve current and future economic well-being.

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