The U.S. economy is on the brink of a crisis.
Tuesday’s release of the Consumer Price Index for August confirmed a disturbing reality: inflation isn’t moderating. This virtually guarantees that the Federal Reserve will continue its path of hiking interest rates, which, as Fed Chair Jerome Powell has said, “will cause pain” to the American economy.
August’s worse-than-expected CPI report also sent stocks falling to their worst day since June 2020 – and though the stock market isn’t the economy, it often is a visible sign of the economy’s health.
Ultimately, there is a very real and increasing possibility of a severe economic downturn in the U.S. – resulting in a recession, or worse, stagflation, which is a combination of persistently high inflation, slow economic growth, and high unemployment.
While many economists predicted that prices would decrease between July and August – due to steadily declining gas prices, which seemed to be giving the economy a respite – the CPI report confirmed the opposite. Prices continued their steady march higher in August, increasing by .1% from July, and 8.3% from a year ago.
Just as alarmingly, Core Inflation, which strips out food and energy, rose twice as much as most economists expected – .6% from July and 6.3% from a year ago – a reflection of rising costs for housing and other essential items.
Even worse, rising prices are showing no signs of subsiding. As Former Treasury Secretary Larry Summers tweeted, this week’s CPI report confirms “that the U.S. has a serious inflation problem.”
“Core inflation is higher this month than for the quarter, higher this quarter than last quarter, higher this half of the year than the previous one, and higher last year than the previous one,” Summers went on to say.
This unrelenting inflation – which continues to climb despite the 25% decline in gas prices over the last several months – underscores how challenging it will be for the Federal Reserve to bring it back to their 2% target.
This current bout of inflation – widespread and “sticky” – is causing concern for economists on and off Wall Street, as the Fed may be forced to take drastic measures to rein in the worst inflation we have experienced in decades.
The Federal Reserve only has one tool to combat inflation: raising interest rates, which essentially puts the brakes on the economy by increasing borrowing costs. This slows down demand for goods and services and typically causes unemployment to rise.
The latest CPI report drastically heightened the prospect of the Fed delivering an aggressive and painful 100bps – or 1% – rate hike. This would be the first hike of this size in more than 40 years, dating back to the late 1970’s when Chairman Paul Volcker was deliberately trying to send the U.S. into a recession in order to tame inflation.
Though, given that this wave of inflation is being caused by limited supply – not purely by strong demand – the Fed risks raising interest rates to a level where they strangle the American economy without immediately curbing inflation.
There could be considerable collateral damage if the Fed goes down this path. The International Monetary Fund has estimated that unemployment in the U.S. would have to double to 7.5% – or roughly 12 million Americans unemployed – in order to crush inflation, triggering another financial crisis in and of itself.
If the U.S. enters a recession – or worse, a period of stagflation – the $7.6 trillion lost in U.S. stocks this year may continue to grow, destroying the household wealth that Americans have built up for years in 401ks and similar plans.
From a political perspective, this week’s economic news poses a tremendous risk to Democrats, who would prefer to head into midterms with positive – or at the very least, neutral – economic news, and want to keep Americans focused on the fight over abortion rights and tying the Republican Party to Donald Trump.
President Biden’s confounding decision to celebrate the passage of his “Inflation Reduction Act” – just hours after the release of a disheartening CPI report – underscores the failure of his administration to develop a reassuring message surrounding this issue, which public polling consistently finds to be Americans’ top priority.
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That being said, the dangers posed to Democrats’ chances of holding onto Congress in November’s midterms pale in comparison to the dangers of what appears to be an inevitable economic and financial crisis.
This crisis will impact all Americans, but especially the most vulnerable among us – namely, seniors and low-income households. Yet, any time the government provides additional aid, it pours gasoline on the inflation fire.
Ultimately, a once-in-a-generation pandemic, years of wasteful government spending, a war in Ukraine, and a Federal Reserve that was too slow to react to inflation have pushed the economy to the brink.
While it remains to be seen when the economy will break, when it does, we can be sure that it will be detrimental to Americans’ jobs, incomes, and overall quality of life.
Douglas Schoen is a longtime Democratic political consultant.