With votes still being counted in the midterms, we still can’t say who will control the Senate, although the makeup of the House is leaning Republican. With divided government, where would economic policy go? To get an answer from both conservative and liberal experts, we spoke to fellows at the Roosevelt Institute and the American Enterprise Institute. Below is Marketplace Morning Report’s David Brancaccio interview with Desmond Lachman, a senior fellow at the American Enterprise Institute, which leans conservative. This is an edited transcript of their conversation.
David Brancaccio: So many voters had inflation on their minds on Tuesday, in what ways do you see the approach to this problem of inflation in Washington perhaps changing now?
Desmond Lachman: Certainly the electorates, they said it was very high on the agenda. But when they voted, it looked like they took other matters into account. So the Democrats strategy of raising other issues like “Democracy’s at stake” or whether it was women’s rights to abortion and so on, seems to have diluted the impact of the inflation issue. You know normally, you would have thought that with inflation running at a 40-year high, right about 8%, with the economy already showing signs of slowing, you would have thought that the economy would have triumphed.
Inflation, inflation, inflation…
Brancaccio: But there remains this problem of inflation and approaches to it. Do you think this divided government that we seem set to have will lead to a different approach to solving that problem?
Lachman: Well, the truth of the matter is that the administration has limited possibility of dealing with the inflation issue. We’ve got a real serious inflation problem and that was caused, in part, by the Federal Reserve being too easy with its monetary policy. Now, the administration can help, you know, if they turn back some of the tariffs, if they release more oil from the strategic reserve. Stuff of that sort might help a little. But the main burden of dealing with the inflation issue is the Federal Reserve through its interest rate policy. So that doesn’t change. But perhaps the Federal Reserve will be now subject to a lot more criticism as the economy turns down. But it’s really going to be high interest rates, slowing the economy that is going to bring the inflation back towards the Federal Reserve’s target.
Brancaccio: Right and you allude to the other problem that the new Congress may be facing next year. I don’t know if we’ll be in a recession. Nine out of ten CEOs surveyed think one is on the way for next year, do you think this divided government will change its approach to what we do about stimulus?
Lachman: Absolutely, that’s where I see one of the dangers of the current political situation. It looks like the United States economy, because of the high interest rates, is going to go into a recession. That’s the way one’s going to bring the inflation down. It’s also occurring in the context of a global economy that looks very troubled. We’ve got problems in China with the zero-COVID tolerance policy, property bust, we’ve got Europe that’s being shut off by Russian gas. All of that makes for a very difficult international environment. And on top of that, the United States economy’s going to be slowing. We’ve also got credit markets that have got credit mispriced. So the chances of getting a recession of a nasty variety – really, we can’t exclude that possibility – and if that does occur, one wouldn’t want to have an administration that is hobbled in the way in which it can respond through big stimulus like we got after 2008, we got it again, after 2020 with the COVID recession. If the economy goes down into a deep recession, one would want the administration to be able to provide an adequate stimulus. But if one has a divided Congress and one’s got a Republican Party that is of the more extreme variety, then the chances of getting an adequate stimulus are diminished. And that means that the recession could be difficult to deal with.
Will we see additional stimulus if a recession hits?
Brancaccio: Yeah, and already the heavy weight on the shoulders of our central bank, the Federal Reserve, that weight gets heavier if in fact, Congress can’t pull it together to know how to respond.
Lachman: Yeah, the Federal Reserve would have to back off its interest rate hiking mode very quickly. You know, they’d have to go into quite a different mode if the economy were to go into a recession, and were we to have financial market problems, they would have to move very quickly. But what they’d also need is that need support from the administration, from Congress, in the form of a budget stimulus policy, you know, to get the economy back on track. So that’s the risk that I see in 2023, you know, later part of 2023. It seems to me, very likely that not only does the United States economy go into recession, but we can have a global recession. And one would need a[n] administration that is capable of responding pretty boldly to that recession.
Brancaccio: You are pretty tapped in. Do you now see conservatives, girding for a big fight over this federal debt ceiling? I mean, $31.4 trillion and you can’t borrow more is the law. I think we’re supposed to hit that sometime next year. Do you think a Republican led house would want to draw a line in the sand over that?
Lachman: They certainly would want to engage in that battle. My expectation is that one will get a theater over the debt ceiling, but in the end the sides will back off, they’ll somehow as they always do, at the last minute, find a compromise. But that can be very unsettling for markets during the process.
The future of big tech
Brancaccio: Is it too early to talk about how the shifting power in Washington will affect how this country regulates big technology companies?
Lachman: Yes, I think that’s … one can already see that the administration’s efforts at doing stuff of an antitrust sort or doing regulation, that will be hampered by having an opposition that’s got control of the House. So that might be a good thing for business in general, that the administration will be limited in what they can do on the regulatory front. So in terms of the tech companies, that would be one issue. Another issue would be in terms of stuff like a windfall profit tax for the oil companies, one could see the administration having difficulty getting anything of that sort through. You know, another thing might be introducing a minimum corporate tax, that might be another issue. All of these issues would need to have a majority in the House. And if one’s lacking that, it’s limited what the administration can do in the remaining two years of office.
Where there’s still bipartisan support
Brancaccio: It might be different, though for another matter. There’s always the matter of trade, especially with China. You do have both parties adopting a strict posture toward what they perceive as abuses of China in the arena of trade.
Lachman: Oh, absolutely. What we’ve seen last year is that the Biden administration, instead of rolling back the tariffs that the Trump administration imposed on China, what they’ve done is they’ve doubled up by putting all sorts of restrictions now on U.S. exports of high tech chips to China. So that is an area, you know, where you could get bipartisan support. That both sides of the aisle seem to be in a protectionist mode in general and pretty hostile towards the Chinese in particular. They see China as being a political threat, and they prepare to engage in a cold war with China on the economic front.
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