Democrats lack the tools they need to fight inflation

The writer is a senior fellow at Brown University and global chief economist at Kroll

America’s Democrats have a problem. They face midterm elections in November with inflation outstripping wage growth, which means standards of living are falling. But there’s very little any president or political party can do about it.

Inflation is impossible for voters to miss, with consumer prices up 9.1 per cent in June over the past year. According to a Morning Consult survey, more than half of voters blame the policies of President Joe Biden, who has made tackling inflation his top economic priority.

Another Morning Consult poll shows that a larger percentage of voters think the president has a lot of control over managing inflation; more than the Federal Reserve (whose official mandate includes price stability), Congress or large companies.

It is no wonder the president has declared inflation “the bane of our existence”. There are some fiscal policies the government could implement to cool inflation, but they would only chip away at prices on the margins — more virtue signalling than actual impact.

The claim that Biden’s 2021 fiscal stimulus overheated the economy and drove prices up isn’t quite right. A San Francisco Fed study found about half the inflationary surge came from supply factors: supply chain problems, China’s Covid lockdowns and Russia’s war on Ukraine. Only about a third came from increased demand. Even if the stimulus did stoke inflation, it is being unwound this year. The US is undergoing the second largest fiscal retrenchment in its history, which will cool demand.

But with US petrol pump prices up more than 40 per cent over the past year and food prices more than 10 per cent, voters haven’t yet noticed. Energy prices are responsible for roughly half the surge in US inflation, yet no president could have the tools to bring them down by election day. The April White House announcement that it would release over 1mn barrels of oil a day from the Strategic Petroleum Reserve stabilised prices for a time. But the International Energy Agency estimates that replaces only about a third of the supply lost to the Ukraine war.

The administration is also urging other producers to ramp up supply. Biden sent senior officials to visit Venezuelan leader Nicolás Maduro, and is reportedly considering easing sanctions on the country in exchange for oil. Biden then went to Saudi Arabia for discussions with Crown Prince Mohammed bin Salman, the kingdom’s day-to-day ruler. He left without a public Saudi commitment to increase production.

So far, the world has not signed on to the US administration’s proposed price cap on Russian oil. While it could help to reduce oil prices, it would no doubt be leaky. India and China would be likely to buy oil at prices just above the cap, and Opec+ would resent the cut in prices.

More oil should mean lower prices. US producers are starting to ramp up drilling, but the Democrats’ desire to increase alternative energy sources limits incentives to invest in carbon assets. One issue with all these efforts is that oil is sold in a global market. Chronic under-investment in fossil fuels and Europe’s turn from Russian energy mean that oil prices will be higher for years, not months. Also, many refineries were mothballed when demand plunged during the Covid lockdown. The lack of capacity means petrol prices will stay high even when oil prices abate.

Congress could vote to increase income taxes, dealing a blow to demand, but that’s a political non-starter. Instead, it is considering suspending the federal levy on petrol — it is about 18 cents a gallon, not much compared with an average price per gallon of about $4.50. Drivers wouldn’t get all the benefits, as energy companies pay part of the tax. Cutting petrol taxes also generates higher demand, pushing prices up.

Biden waived environmental rules, enabling ethanol to be added to petrol in the summer driving season. But only 2,300 petrol stations countrywide carry this mix. Agricultural analysts worry increased demand for corn to make ethanol could push farmers to shift production from wheat, fuelling food inflation.

Beyond oil and gas, the Biden administration wants to crack down on price gouging by firms in industries that lack competitiveness. A White House analysis, for example, found high concentration in the meatpacking industry drives prices up. A poll this year showed more than half of voters blame inflation on a lack of competition among companies but roughly two-thirds of economists disagree. Market concentration has been elevated across a number of US industries for years without sparking an acceleration in inflation.

Biden could cut tariffs. According to a study by the Peterson Institute, removing the Trump tariffs on $360bn of Chinese imports might lower consumer price inflation by 1 percentage point. This might not be worth ceding leverage to China in trade negotiations. A broader 2 percentage point tariff-equivalent reduction could reduce the CPI by 1.3 percentage points. Still, the impact would mostly be on merchandise, not where inflation hits the hardest – fuel, food and housing.

This makes Biden’s first point in his inflation-busting plan the most effective move for Democrats: leave it up to the Fed to fight inflation. It will take time and there’s a risk that the Fed sparks a vote-killing recession. If bringing down inflation is the top priority, though, that is the one thing guaranteed to work.