The defining issue of Joe Biden’s presidency is not climate change, geopolitics or even Covid. It is inflation — and while it is an existential threat to his political career, it also presents an opportunity for him and moderate Democrats to fulfill some long-sought policy goals.
What’s less appreciated are the opportunities inflation opens up. In general, inflation eases some of the short-term concerns most troubling to moderate Democrats, while bringing the long-term challenges they have often cited into sharp relief.
The clearest example of this dichotomy is the federal debt. Over the last few years the government has racked up record deficits fighting the pandemic. At the same time, the debt-to-GDP ratio is falling by nearly 5% per year. That’s because rising prices have increased the nominal size of the economy, and with it the amount of money the government collects in tax revenue.
The interest rate that the federal government pays on its debt, however, hasn’t risen by nearly the same amount. The net result is that the debt is growing at a slower rate than the overall economy, and so the debt-to-GDP ratio is falling. Any lingering fears that Covid spending would send the debt spiraling out of control should ease.
Yet this relief won’t last long. The Fed has already started to raise interest rates in an attempt to bring inflation under control.
Those rate increases will slow the nominal growth rate of the economy and increase the growth rate of the federal debt, reversing the current trend. The administration has short window of opportunity to act on the deficit — and it needs to use it.
Fortunately, inflation (and the high-pressure economy that’s producing it) may give moderates some leverage. Several major elements in Biden’s economic agenda involved easing the burden on working families. For example, paid leave, child-care subsidies and universal pre-K all shared a goal of giving more flexibility to single parents, working mothers in particular.
Although the administration claimed it could fund these programs by taxing the wealthy, making them permanent would have either required broad-based tax increases or led to a sharply rising deficit.
Yet the current economy, in which business sales are rising faster than employee compensation, has created a worker shortage. In response, employers are being forced to adopt more flexible policies that meet the needs of working parents. For professionals, this has resulted in increased opportunities for remote work and workdays outside of the traditional nine-to-five schedule. For working-class parents, it’s meant a job market that is finally tilted in their favor: Employers have to accommodate their schedules, not the other way around.
In short, the market is relieving the underlying issue of inflexible work schedules without Congress having to agree on a specific package of benefits and the taxes to pay for them. To be clear, this transition is not without its costs. It is occurring precisely for the same reason that is driving down real median earnings: business sales rising faster than employee compensation.
At the same time, inflation also shows that the most effective way to elevate living standards for workers is through increasing the supply of goods and services, thereby easing the shortages and price increases that accompany them. Democrats’ initial approach focused on subsidizing favored industries such as semiconductors while punishing disfavored ones such as meatpacking.
To have a real impact on inflation, however, the administration needs focus on problems such as the double-digit increases in rents. That could mean putting pressure on the states to reduce restrictions on residential construction by, say, linking transportation and transit funding to increases in multifamily building permits.
The path of inflation over the next few years will determine the Democrats’ fate in both the midterm and presidential elections. Of course they are wary of the political fallout — but Democrats should not be blind to the policy opportunities. They should acknowledge that the economy has already helped them achieve some of their domestic goals, and turn their attention toward long-term deficit reduction and realistic efforts to increase supply.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Karl W. Smith is a Bloomberg Opinion columnist. He was formerly vice president for federal policy at the Tax Foundation and assistant professor of economics at the University of North Carolina. He is also co-founder of the economics blog Modeled Behavior.
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