Despite unprecedented jobs growth in the United States, inflation remains tepid. More experts have now embraced the idea that insufficient demand is largely to blame for falling economic growth.
While it is true that structural factors have contributed to lower private demand, policy-related uncertainty is on the rise and making matters worse. Recent events contributing to the rise of policy uncertainty include President Trump’s trade wars, job-killing border delays for lawful US residents and the Democrats’ war on wealth creation.
Inflation expectations are continuing to fall
In early June 2019, the New York Fed reported in its Survey of Consumer Expectations that the public expects to see slower increases in price pressures over the coming years. Actual inflation has also weakened.
These results are in contrast with experts’ predictions. Strong job market growth usually leads to higher inflation expectations, and the US has undoubtedly been experiencing robust jobs growth. The month of May 2019 marked 102 consecutive months of jobs growth in the United States. Furthermore, in May 2019, the US unemployment rate was 3.6 percent, the lowest it has been in 50 years (the US civilian unemployment rate was 3.4 percent in May 1969). However, despite 10 years of falling unemployment, inflation – measured by the change in the personal consumption expenditure (PCE) index – remains below expectations.
This time last year, low inflation had prompted many economists to announce the death of the Phillips Curve.
Wage growth has remained below expectations. Experts have suggested a variety of explanations for this conundrum. It is certain that US’s sluggish productivity growth translates into lower wage growth. However, workers’ wages depend on more than just their productivity; they also depend on workers’ bargaining power relative to their employers.
Given low unemployment rates, one would expect employees to have increased bargaining power resulting in higher wage growth.
Some economists blamed low wage growth on the rising power of big corporations and falling union membership rates. Others blamed cheaper foreign workers and automation.
Another group of experts, led by Dr. Adam Ozimek, suggested that the government’s definition of unemployment, which only includes those actively seeking employment, failed to capture the broader pool of individuals who were making their way back into the labour force. In theory, as long as employers were able to continue tapping into a large pool of jobless Americans, higher wage offers were not necessary to fill vacancies.
Regardless of which theory best fits the data, so long as inflation expectations continue to decline, wages are not going to increase by much.
Can policy-related uncertainty share some of the blame?
The economic policy uncertainty index can provide some clues as to why inflation expectations are falling and wages are not rising very much.
When there is uncertainty about who will be making policy decisions, what those decisions will be and how they will affect the economy, individuals and businesses who have money to spend will likely pause before writing a check.
Economists Scott Baker, Nicholas Bloom, and Steven Davis documented the rise in economic policy-related uncertainty. They found that the rise in policy uncertainty coincides with: 1) growth in government spending, taxes and regulation (in scale and complexity) and 2) increased political polarisation. The payoffs associated with private economic decisions are increasingly affected by government activities and policies that are subject to change. In response, people and businesses are cautious. They spend less and save more resulting in lower growth and declining interest rates.
Using data for 12 major economies, the authors found that growing economic policy uncertainty from 2006 to 2012 accounted for a 45% increase in stock price volatility for publicly listed US firms. As expected, innovations in policy uncertainty foreshadow declines in investment, output and employment.
What the 2020 US presidential election could mean for your wallet
National elections often produce spikes in policy uncertainty. This means that the US economy is expected to slow down regardless of who becomes America’s next president.
Parties shout past each other, rather than talk to each other and bi-partisan policymaking can besmirch a politician’s reputation, getting him or her labelled as a defector. Since parties are not able to work together, congress is constantly gridlocked. Rather than work through the political process, presidents are more frequently superseding it through executive orders.
These executive orders can be easily reversed by the next president. They do not have the same permanence and protection as laws.
Over the presidencies of Obama, Trump and arguably Bush, the number of important executive orders has increased, surely contributing to rising policy uncertainty. These executive orders have a substantial impact on economic decisions. However, these policies can also disappear just as quickly as they came into place. For example, notice how quickly Trump reversed many Obama-era climate protections, which had a tremendous effect on the fossil fuel industry and other big businesses. The Trump administration reversed or rolled back more than 80 environmental rules and regulations.
During election years, the public is even more aware that swift and substantial policy changes could be approaching. Executive orders allow the flip-flops to occur even faster, as presidents can swiftly dismantle the legacy of the other party. As the public is more aware that policy could be changing quickly and it is not aware of which way those changes could go, or how they will be affected, economic activity will come to a standstill. They will decrease spending and increase saving, which will damper economic growth.
If the first two Democratic debates are any indication of things to come, a Democratic President would dismantle most of Trump’s executive orders and also try to take away most Americans’ private health insurance, limit gun ownership, allow for federal funding of abortions and liberalise immigration.
Joe Biden and Elizabeth Warren want to spend trillions of dollars on ways to curb climate change. Kamala Harris wants to mandate higher wages but slash federal revenue by giving thousands of dollars to millions of Americans. Harris also backed Bernie Sanders’ Medicare-for-all legislation which would require increasing federal revenue by as much as $32 trillion.
Most candidates promise large federal spending increases but only a handful are prepared to discuss how they want to pay for the new spending.
Elizabeth Warren wants to penalise wealth creation by introducing a wealth tax that leading experts say would still fail to generate enough revenue to pay for her proposed spending.
Sanders proposed a 77 percent tax rate on billionaire estates and a financial transactions tax.
Raising this much new revenue would require broad-based tax hikes that would also affect the middle class. Most experts prefer consumption taxes because income and wealth taxes end up harming hard working families.
Nearly every single Democratic candidate proposes a dramatic expansion in the size and scope of government, massive budget deficits or higher taxes on most Americans. These policies would represent a massive shift from the Trump administration. Depending on who wins, policy will look very different and have divergent effects on businesses and individuals.
How the leading Democratic candidates’ policy agenda could affect the US economy
For an example of things to come, one can simply look at the US state of Illinois. Democrats have had control of state government for 13 of the last 17 years. Illinois has the lowest income growth of all US states and an unemployment rate that sits well above the rest of the country. Since the election of billionaire Governor J.B. Pritzker, it only took six months for Illinois Democrats to enact a 80 percent income tax increase to squeeze millionaires for an estimated $3.4 billion while still squeezing the middle-class for another $6.9 billion with 19 different tax and fee hikes. These tax increases are peanuts compared to what the Democratic presidential candidates are proposing.
Most serious economists argue that higher taxes deter new investments harming economic growth and that an increase in taxes faced by entrepreneurs reduces small business employment, the wages of their employees and overall business growth.
What the next administration should focus on
Regardless who wins the next election, Republicans and Democrats should come together around a long-term vision for the country.
On the spending side, the US is in desperate need of infrastructure repair, not shiny politically motivated new expensive projects. The experts are unanimous in supporting a “Fix it First” approach because maintenance is likely to deliver higher returns for taxpayers and to boost US economic growth.
A fall in the US natural population increase (excess of births over deaths) raised the importance of immigration reform for US growth. Immigration has mostly contributed to boosting US economic growth and innovation. As a result, steps to offset declining population growth could improve the US economic outlook.
Bipartisan policy solutions could provide a sense of continuity between administrations and mitigate the increase in policy-related uncertainty.