Peter Coy: Paul, I think the economy is going to be a huge problem for President Biden in 2024. Voters are unhappy about the state of the economy, even though, by most measures, it’s doing great. Imagine how much unhappier they’ll be if things get worse heading into the election — which I, for one, think is quite likely to be the case.
Paul Krugman: I’m not sure about the politics. We can get into that later. But first, can we acknowledge just how good the current state of the economy is?
Peter: Absolutely. Unemployment is close to its lowest point since the 1960s, and inflation has come way down. That’s the big story of 2023. But 2024 is a whole ’nother thing. I think there will be two big stories in 2024. One, whether the good news continues and, two, how voters will react to whatever the economy looks like around election time.
Paul: Right now many analysts, including some who were very pessimistic about inflation last year, are declaring that the soft landing has arrived. Over the past six months, the core personal consumption expenditures deflator — a mouthful, but that’s what the Federal Reserve targets — rose at an annual rate of 1.9 percent, slightly below the Fed’s 2 percent target. Unemployment is 3.7 percent. The eagle has landed.
Peter: I question whether we’ve stuck the soft landing. I do agree that right at this moment, things look really good. While everyone talks about the cost of living going up, pay is up lately, too. Lael Brainard, Biden’s national economic adviser, points out that inflation-adjusted wages for production and nonsupervisory workers are higher now than they were before the Covid pandemic.
So let’s talk about why voters aren’t feeling it. Is it just because Biden is a bad salesman?
Paul: Lots of us have been worrying about the disconnect between good numbers and bad vibes. I may have been one of the first people to more or less sound the alarm that something strange was happening — in January 2022! But we’re all more or less making this up as we go along.
The most informative stuff I’ve seen recently is from Briefing Book, a blog run by former White House staff members. They’ve tried to put numbers to two effects that may be dragging consumer sentiment down.
One effect is partisanship. People in both parties tend to be more negative when the other party controls the presidency, but the Briefing Book folks find that the effect is much stronger for Republicans. So part of the reason consumer sentiment is poor is that Republicans talk as if we’re in a depression when a Democrat is president, never mind reality.
Peter: That is so true. And I think the effect is even stronger now than it used to be because we’re more polarized.
Paul: The other effect affecting consumer sentiment is that while economists tend to focus on relatively recent inflation, people tend to compare prices with what they were some time in the past. The Briefing Book estimates suggest that it takes something like two years or more for lower inflation to show up in improved consumer sentiment.
This is one reason the economy may be better for Democrats than many think. If inflation really has been defeated, many people haven’t noticed it yet — but they may think differently a little over 10 months from now, even if the fundamentals are no better than they are currently.
I might add that the latest numbers on consumer sentiment from several surveys have shown surprising improvement. Not enough to eliminate the gap between the sentiment and what you might have expected from the macroeconomic numbers, but some movement in a positive direction.
Peter: That makes sense. Ten months from now, people may finally be getting over the trauma of high inflation. On the other hand, and I admit I’m not an economist, I’m still worried we could have a recession in 2024. Manufacturing is soft. The big interest rate increases by the Fed since March 2022 are hitting the economy with a lag. The extra savings from the pandemic have been depleted. The day after Christmas, the Federal Reserve Bank of St. Louis said the share of Americans in financial distress over credit cards and auto loans is back to where it was in the depths of the recession of 2007-9.
Plus, I’d say the labor market is weaker than it looked from the November jobs report. (For example, temp-agency employment shrank, which is an early warning of weak demand for labor.)
Also, small business confidence remains weak.
Paul: Glad you brought up small business confidence — I wrote about that the other week. Hard indicators like hiring plans are pretty strong. Soft indicators like what businesses say about future conditions are terrible. So small businesses are in effect saying, “I’m doing OK and expanding, but the economy is terrible” — just like consumers.
I’m not at all sure when the Fed will start cutting, although it’s almost certain that it eventually will, but markets are already effectively pricing in substantial cuts — and that’s what matters for the real economy. As I write this, the 10-year real interest rate is 1.69 percent, down from 2.46 percent around six weeks prior. Still high compared with prepandemic levels, but financial conditions have loosened a lot.
Could there be a recession already baked in? Sure. But I’m less convinced than I was even a month ago.
Peter: The big drop in interest rates can be read two ways. The positive spin is that it’ll be good for economic growth, eventually. That’s how the stock market is interpreting it. The negative spin is that the bond market is expecting a slowdown next year that will pull rates down. Also, what if the economy slows down a lot but the Fed doesn’t want to cut rates sharply because Fed officials are afraid of being accused by Donald Trump of trying to help Biden?
Paul: I guess I think better of the Fed than that. And always worth remembering that the interest rates that matter for the economy tend to be driven by expectations of future Fed policy: The Fed hasn’t cut yet, but mortgage rates are already down substantially.
Peter: Yes.
Paul: OK, about the election. The big mystery is why people are so down on the economy despite what look like very good numbers. At least part of that is that people look not at short-term inflation but at prices compared with what they used to be some time ago — but people’s memories don’t stretch back indefinitely. As I said, the guys at Briefing Book estimate that the most recent year’s inflation rate is only about half of what consumers look at, with a lot of weight on earlier inflation. But here’s the thing: Inflation has come way down, and this will gradually filter into long-term averages. Right now the average inflation rate over the past 2 years was 5 percent, still very high; but if future inflation runs at the 2.4 percent the Fed is now projecting, which I think is a bit high, by next November the two-year average will be down to 2.7 percent. So if the economy stays where it is now, consumers will probably start to feel better about inflation.
Peter: Except that perceptions of inflation are filtered through politics. Food and gasoline are more expensive for Trump supporters than Biden supporters, if you believe what people tell pollsters. That’s not going to change between now and November.
The Obama-Biden ticket beat the McCain-Palin ticket in 2008 because voters blamed Republicans for the 2007-9 recession. Obama-Biden had a narrower win in 2012 against Romney-Ryan, and I think one factor was the so-called jobless recovery from that recession. That’s why Biden is supersensitive about who gets credit and blame for turns in the economy.
For the record, Trump might be president right now if it hadn’t been for the Covid pandemic, which sent the unemployment rate to 14.7 percent in April 2020. The economy was doing quite well before that happened. A lot of Republicans are nostalgic for Trumponomics, although I think the economy prospered more in spite of him than because of him. Thoughts?
Paul: Most of the time, presidents have far less effect on the economy than people imagine. Big stimulus packages like…