Political Posturing: Prospects For Inflation?

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There has always been considerable hyperbole about American elections -- "the most important election since 1920," or some such. Conversely, from the perspective of economic institutions, it is hard to see any fundamental changes since the early 1990's. Up until earlier this month, my base case was that the Biden administration would be replay of the Obama one. However, one can see a story where things have fundamentally changed.

I am in awkward position with respect to political economy. I believe it is important, but do not like writing about it. However, if we want to talk about the multi-year prospects for inflation, we need to dip into politics.

Inflation: an Institutional Process

The past decade has not been kind to inflation theories that rely on a single variable, like the money supply. The debate around $2000 transfer has underlined the basic premise of Functional Finance -- inflation is the result of the stance of fiscal policy. However, we cannot replace the money supply with a single fiscal variable to get a viable inflation theory; inflation is the result of the interaction of all economic policies with the business cycle. 

The post-1990 era saw an overall policy stance that favored low and stable inflation in the developed countries. Although the price level certainly jumps around, if we are looking at long-run average inflation, we need to look at the policy stance. For the post-1990 era, the correct answer always was that the policy stance would not change. Is this time different?

Republican Party at a Crossroads

My usual bias is to expect institutional inertia. Before this month, I expected that the Republican Party would act in an obstructionist manner, forcing the Biden administration to follow the path of the Obama one. However, events this month have called that into question.

The first point of difference is that the Republicans lost control of the Senate. The second is that the events in Washington D.C. could easily force a fissure in the Republican Party political coalition. The worst case scenario for the Republicans is for their stance to be driven by extremely polarizing views held by 30% of the voting population. That 30% is enough to determine primary winners, but would result in a shellacking in the general election. 

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Disclaimer: This article contains general discussions of economic and financial market trends for a general audience. These are not investment recommendations tailored to the particular needs of an ...

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