Americans are deeply disappointed in President Joe Biden’s performance on the economy. Almost two-thirds of voters say that the country is on the wrong track, almost half say the economy will worsen next year and, by a 29-point margin, more expect inflation to get worse rather than better.
I certainly have had my criticisms of the Democrats’ economic policy. But it’s important to note what they got right — and ask what they could have done, and could do, better.
It’s important to review some recent history: When the global financial crisis struck in 2009, Washington acted quickly to stem the collapse and prevent a repeat of the Great Depression. Then they largely the dropped the ball. The recovery was slow, painful and resulted in millions of Americans becoming so discouraged that they left the workforce altogether.
Some economists argued at the time that this was the best that could be expected. Others of us argued that the solution was straightforward: The economy was suffering from a deficit of demand — that is, overall spending wasn’t enough to produce jobs for everyone willing to work. The goal of policy should have been to make up that deficit.
In particular, the nominal gross domestic product had fallen well below the trajectory it was on before the crisis. (Nominal GDP is the measure of a country’s output at current prices; real GDP is adjusted for inflation.) The Federal Reserve should have promised to keep interest rates low until it had made up the difference.
The intuition is that people don’t adjust for inflation as they go about their day and plan their lives. They take on mortgages, agree to salaries and start new businesses based on the actual dollar amounts involved. When suddenly they don’t have enough money, because of an economic crisis, their plans fall into disarray.
The solution to this dilemma is to bring the total amount of nominal income flowing through the economy back to previous levels. Then hiring will recover and the economy will enter a virtuous and self-reinforcing cycle.
Remarkably, this is almost precisely what has happened over the last year and a half. The U.S. economy went into a brief recession because of COVID, but through a combination of fiscal relief and monetary support, nominal GDP is now back on track. As predicted, unemployment has fallen, hitting 4.2 percent last month, just 0.7 points higher than before the pandemic.
Yet this solution comes with a cost: above-average inflation during the pandemic itself. After all, if real GDP shrinks — and that’s what the recession was — then in order for the total volume of spending to remain the same, prices have to rise to make up for the shortfall. Indeed, that is also almost precisely what has happened.
The economic theory here is that a short period of inflation is a price worth paying to reduce unemployment. As a political strategy, however, it is a non-starter.
Some of this is surely due to poor communication on the White House’s part. For example, Biden could have been quicker to address the supply-chain slowdowns at the ports and shown more support to an oil and gas industry that is apprehensive not only about how COVID will change consumer behavior but also about the administration’s climate policy.
More broadly, Biden should have been more candid about the choice the U.S. was facing: between a lingering recession and a short bout of inflation. He could have made the argument that his administration was not going to repeat the mistakes of the early 2010s. If he had, maybe Americans would have been more willing to accept rising prices.
Of course, it would be foolish to believe that any of this would have meaningfully changed Americans’ overall sense of the economy. Restoring nominal GDP to its pre-crisis trajectory is a real achievement, but it has unavoidably induced a period of rising prices. The public just doesn’t like inflation, no matter what economists or politicians might say. And while economists — or columnists — don’t have to face the voters’ wrath, presidents do.
Karl W. Smith is a Bloomberg Opinion columnist.