A ‘Biden boom’? Inflation makes economy feel like a bust to many.

It’s the kind of record any president would envy. Economic growth in 2021 is forecast to have reached a 38-year high. Jobs are being added at a historic pace. The administration – and some others – are calling it the “Biden boom.”

But the American public is skeptical. After one year in office, President Joe Biden’s approval rating is slipping to lows that Donald Trump experienced for most of his presidency.

A key reason? Inflation is also on a tear and is beginning to undercut the otherwise thriving economy that Mr. Biden inherited. The damage is minimal so far, but the trends are ominous for Democrats. The Federal Reserve is likely to begin throttling back growth just as voters begin to make up their minds about the direction of the economy. When they go to the polls this November to vote for members of Congress, will they perceive a Biden boom or a sticker-shock bust?

Rising prices are important for ​reasons that go well beyond politics. When untamed, inflation itself can threaten economic growth by eroding consumer and business confidence – and damaging household finances as prices surge faster than incomes. And if Americans expect ​it to be lasting, they will make purchasing decisions that exacerbate inflation and complicate the Fed’s efforts to control it.​

“The Fed is behind the curve,” says Frederic Mishkin, an economist at Columbia Business School and former Fed governor. “They are going to have to tighten more than they otherwise would.”

To counteract inflation, central bankers typically “tighten” monetary conditions – by raising interest rates, for example. However, those actions can cool demand and slow the economy, often resulting in a recession. And if there’s one thing voters like even less than inflation, it’s slow or negative economic growth, research shows.

This is what scares Democrats. Heading into midterm elections where their prospects for holding onto the House and Senate already look shaky, they don’t want to get saddled with high inflation or a weak economy. At his first solo press conference in 10 months, Mr. Biden on Wednesday acknowledged that inflation was bad: “People see it at the gas pumps, the grocery stores, and elsewhere.” And he endorsed efforts to fight the surge in prices, pointing out that it was the Fed’s responsibility.

Inflation rises on the worry list

The surge in prices is undeniable. Inflation last month rose at an annual rate of 7%, the highest 12-month increase since 1982, according to the Bureau of Labor Statistics. Even using “core inflation” measures, which strip away sectors where prices can swing widely, the price surge is ratcheting up. 

And its effects are beginning to be felt. Average hourly earnings rose by a strong 4.7% for 2021, but that turns out to be more than a 2% pay cut once adjusted for inflation. An index of consumer sentiment is lower now than during a spring 2020 dip as the pandemic began.

The Biden administration pins the blame on the pandemic and says supply chain issues will get worked out over time and inflation will then abate.

“Given that it is a supply-demand mismatch that really is a result of the pandemic, the reason ... forecasters are expecting that inflation will ease is we do expect that this pandemic will moderate,” Cecilia Rouse, chair of the White House Council of Economic Advisers, said in an online symposium with the Council on Foreign Relations last week. 

That argument becomes harder to make the longer high inflation persists. In a Conference Board survey of U.S. CEOs released last week, inflation was the No. 2 external challenge after labor shortages; a year ago, it barely registered on CEOs’ radar at No. 22. Even Federal Reserve policymakers, who spent most of last year agreeing with the administration that inflation was transitory, have dropped the term and are signaling a tougher stance. 

Did federal stimulus play a role?

Conservatives point to another major culprit for inflation: federal spending. Many economists applauded the initial $2 trillion pandemic relief act that President Trump signed in early 2020 for containing the economic damage after government-mandated shutdowns. But subsequent Trump spending measures poured another $2.8 trillion into the economy, followed by $2.7 trillion in Biden initiatives, with promises to spend even more. That money has pumped up demand. 

“To this day, [Democrats and their supporters] blame the inflation on supply-chain problems and the usual suspects: big business, insufficient antitrust enforcement and greedy profiteers,” write former Senate Banking Committee Chairman Phil Gramm and Mike Solon of US Policy Metrics, an economic and public policy research firm in Washington, in an op-ed for The Wall Street Journal. “They never blame government.” 

Inflation is not uniformly bad. Like other economic changes, it creates winners as well as losers. Homeowners see the value of their homes go up and the burden of fixed-rate mortgages go down. Renters, by contrast, see only rising rents. A recent Bank of America study found that lower-income and less-educated households save less and are spending a greater percentage of their incomes on high-inflation goods, such as energy, food, and cars and trucks, than higher-income and more-educated households are. The inflation surge has cut the spending of households where no one holds a college degree by 4.6% versus only 3.0% for those with a college degree.

Forecasting when inflation falls is difficult, even without the complications of a pandemic. The latest survey of professional forecasters, released in November, called for the consumer price index to drop back to a 2.5% or lower annual rate of growth in the second half of this year. Now, some forecasters see the Fed imposing three quarter-point increases this year in the federal funds rate, which the central bank typically uses to influence short-term interest rates.

Even with those moves, the federal funds rate would still be below a percentage point, hardly an aggressive tightening, points out Laurence Ball, an economist at Johns Hopkins University in Baltimore.

If the pandemic ends over the course of this year, it’s still reasonable to expect inflation to slow and the economy to bounce back without drastic action from the Fed, he adds. But “I’m in the group of people that has been somewhat chastened. I wrote things early last year that this [inflation] thing would be gone pretty soon, and that hasn’t been the case.”