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Can Congress Beat Inflation? | Insight

Democrats hope they can pass deficit-reduction legislation before the midterms. But what will that actually do?

The Briefing: Two reconciliations?

  • Remember Build Back Better?
    • Last year, Joe Biden tried to enact a expensive legislative package known as "Build Back Better"
    • It included spending on housing, healthcare, childcare, and climate
    • But Senators Joe Manchin and Kyrsten Sinema divided the Democratic effort
  • Joe Manchin and the Democrats
    • Recent reports suggest Joe Manchin has been meeting with Senate Majority Leader Chuck Schumer
    • They're hashing out a much smaller legislative package
    • Their reconciliation (haha) could give Democrats a win to tout in the midterms
  • A reconciliation bill?
    • Manchin wants bipartisan support but is open to using reconciliation (read our explainer on that here)
    • The bill would include some new spending but would primarily raise revenue to reduce the federal deficit
    • $500 billion: new spending on tax credits for clean energy (and some fossil fuels) and subsidies for the Affordable Care Act (ACA)
    • $1 trillion: revenue raised by implementing the long-discussed global minimum corporate tax and by beefing up the IRS

The Big Question: What will the bill do?

When we evaluate legislation, it’s important to ask what exactly it’s supposed to accomplish. Before I get to that, however, I think it’s worth evaluating—given how shambolic Democratic governance has been over the past year and a half—just how likely it is that this rumored bill is passed.

To put it bluntly, I’m somewhat skeptical. Current reporting indicates that the process of negotiation is in very early stages, with just five or so months to go until the midterms. Right now, the discussions seem to be taking place exclusively between Manchin and Schumer, with Manchin’s fellow holdout Kyrsten Sinema not yet involved in the process. The White House is also not a party to the talks, and neither is the Democratic leadership in the House.

Given how sluggish Congress is when putting together legislation, and how likely Democrats are to lose one or both chambers of the legislature in the midterms, there’s a way to go with little accomplished. Moreover, for Democratic incumbents in swing districts in the House, there’s an incentive to run away from the party establishment and not with it.

But on the other hand, passing legislation is certainly within the realm of possibility, however slim. First of all, the new bill is a lot smaller than even the slimmed-down $1.5 trillion Build Back Better legislation that was on the table last fall. Moreover, the ACA subsidies that are being discussed are renewals of old subsidies that are set to expire at the end of the year, leaving only a narrow window for Democrats to keep them in place before they likely lose power. That may induce a sense of urgency that facilitates compromise.

Finally, and most importantly, the bill—by raising $1 trillion in new revenue—is being sold as principally about deficit and inflation reduction. Among more conservative Democrats, deficit reduction is seen as signaling fiscal credibility, something that the party could run on in the fall. And by taking money out of the economy (which higher taxes and a beefed-up IRS would do), they can claim that they’re fighting to reduce inflation.

But will the bill actually do that?

The Theory: Economists say, “Not so fast.”

Some basic macroeconomics: There are two ways that the federal government can manage the economy: fiscal and monetary policy. Monetary policy is the prerogative of the Federal Reserve, which can expand the money supply (and thus speed up economic growth) in a recession, and contract it when there’s a risk of inflation. In theory, Congress can use fiscal policy to stimulate economic expansion by borrowing money in a recession, and contract the economy by raising taxes or cutting spending whenever it’s running too hot.

Some orthodox economists, however, are skeptical of fiscal policy as a tool for fighting inflation. First of all, they doubt that incumbent politicians would actually want to slow the economy down in an election year, because voters tend to judge incumbents based on the economy’s performance. In this sense, what’s being discussed by Manchin and Schumer actually cuts against economists’ theories, because the bill they’re discussing would implement contractionary policy right before an election. But with inflation as high as it is, the exception to the rule makes some sense.

More importantly, perhaps, the link between deficit reduction and inflation isn’t always clear. Reducing the deficit can bring prices down, but it’s hard to say if it will, or by how much. Moreover, the political incentives that drive Congress may lead to a lack of coordination between its policies and what the Federal Reserve does, which may not be particularly helpful.

The Takeaway: The enduring supremacy of politics.

Deficit reduction could help a little bit with inflation, or it could make the economic situation worse by pushing the country towards a recession. The economist and blogger Joseph Politano recently suggested that the country’s fiscal situation is already tightening, even with the Federal Reserve planning to continue to pursue contractionary monetary policy through the end of 2022. While the Federal Reserve strives to engineer a “soft landing”—that is, reducing inflation without causing a major recession, Congress might muck things up by pursuing its own policy simultaneously.

More likely, however, is that a deficit reduction bill won’t do very much for inflation at all, except signal that Democrats care about bringing prices down. And even if the legislation actually does help reduce prices, it’s likely that such an effect won’t be felt until after the midterms.

Despite all of this, however, the necessities of politics suggest that, for their own good, Democrats would be wise to agree to just about anything that Manchin is proposing. Demonstrating even a minimal degree of competence and cooperation before the midterm elections could blunt the losses that the party is almost sure to incur. Beyond that, the more important fact is that the climate crisis continues to worsen, and Democrats will probably not have another chance to confront it in the coming years. Getting anything done now is not just a political but a practical necessity.

Finally, it’s probably too much to expect pristine economic policymaking from legislators; the demands of democratic politics are just too distorting, no matter how worthy the tradeoff. There are degrees of better and worse, of course, but if the past year and a half of Congressional gridlock have taught the nation anything, it’s that aiming for what’s possible—rather than what’s perfect—ought to be the objective.

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