The Politics Of Inflation

Assessing the outlook for inflation is hard enough right now if you’re committed to objectivity and steeped in the debate.

Just ask the Fed, an economist or any analyst on Wall Street.

That’s not to say policymakers, academics and analysts don’t harbor political biases. Nor is to suggest that being an economist means you’re more likely to be right. Indeed, sometimes deeply ingrained biases go a long way towards explaining why someone holds the position they hold. That’s especially true at Treasury and the Fed. And we all know being an economist in many cases means being wrong about economics. It’s almost a job requirement.

For our purposes here, the point is just that policymakers, academics and analysts are less likely to allow their biases to completely corrupt their projections. The Fed didn’t get inflation wrong because they unconsciously (or consciously) wanted Joe Biden to be a popular president. They got inflation wrong for many of the same reasons Wall Street got it wrong.

The general public, on the other hand, has no qualms whatsoever about allowing political affiliation to completely dictate how they think about the world. That’s never been more true than it is today. For the past five years, Americans have largely existed in two alternate realities that rarely overlap. Everyone has an opinion on whose fault that is, but if there’s one thing most people agree on, it’s that the two sides shall never meet to agree on anything. Inflation included.

I’ve spilled gallons of digital ink documenting so-called “K-shaped’ inflation, the phenomenon in which rising prices affect households differently based on demographics. The longer prices remained elevated this year, and the more inflation broadened out, the more uniform the increase in expectations became. But the phenomenon was still evident in the latest installment of the NY Fed’s consumer survey.

Two things stick out in the figure (below). Near-term expectations are still very elevated for the least educated and least well off households, while longer-term expectations for those making $100,000 or more and for those with at least a bachelor’s degree remain generally well anchored (below 4%).

Again, I should emphasize that things are quite a bit more convoluted now than they were earlier this year. For example, expectations among the “some college” cohort are now more elevated than the no college group. And, as you can see from the visual, the gap is now closing for three-year ahead expectations. But relatively stable longer run expectations among those who are more educated and make more money have been a fixture of this data for the duration of the pandemic era.

Of course, K-shaped inflation is real. There’s a reason why inflation expectations can vary widely by income cohort and education level. I’ll recycle some language I’ve used previously. The fact that price expectations among the undereducated have been markedly higher than those for consumers with college degrees isn’t explainable by reference to the former’s deficient math skills. That is: It’s not that people who didn’t go to college lack the capacity to accurately forecast inflation. In fact, it sometimes seems like the more college degrees you have, the less capable you are when it comes to economic forecasting. The problem for the undereducated is that they tend to spend a larger percentage of their relatively meager incomes on goods and services for which prices are rising the most. And those with a college degree tend to make more money, which means the education and income cohorts overlap.

So, it’s obvious why inflation expectations should differ (especially in the short-term) by education and income level. While you’d expect some variation along partisan lines, it’s not obvious that it should be extreme, except by reference to America’s hopelessly polarized political environment. The final read on the University of Michigan sentiment survey for December betrayed a partisan divide so large for the year ahead that it was difficult to explain it without suggesting, as the survey’s chief economist, Richard Curtin, did Friday, that “the partisan nature of consumer expectations has overwhelmed other economic correlates.”

As Curtin noted, Democrats anticipate 3% inflation for the year ahead, half of November’s 5.7% YoY headline PCE reading. Republicans, on the other hand, see inflation running 6.8% in the year ahead. Longer-term expectations betrayed a similarly absurd partisan divide. Democrats see inflation running 2.3% over the long run, Republicans 4.4%.

And it gets better. Or worse, depending on how you want to look at it. Curtin observed that “three times as many Republicans as Democrats cited the negative impact on their finances from inflation,” a stunning 47% to 16% disparity. Similarly, Democrats expect nominal income gains of 2.7% to Republicans’ 0.4%.

That plainly suggests partisan affiliation is the only lens through which Americans are capable of viewing the world in 2021.

You could, of course, attempt to explain the disparities highlighted by Curtin by reference to characteristics associated with Democratic and Republican voters. But that exercise is complicated immeasurably post-2016 by the extent to which Donald Trump broadened the Republican base.

For decades, the GOP has been an awkward coalition of voters with virtually nothing in common economically, united by (sometimes fanatical) devotion to a set of purported “American values.” Trump reinforced that, in part by making the implicit explicit on issues related to race, creed and religion. In the process, he pulled in countless Americans who are undereducated and underpaid. That could account for a portion of elevated inflation expectations among GOP voters.

But in all likelihood, the controlling factor is partisanship for the sake of it. Curtin underscored as much. “Independents equaled the median expected income response across partisan subgroups,” he said. “This… indicates that partisan extremes generally offset and the sum is approximately equal the views of Independents.”

Now if only there were enough Independents out there to win an election (any election besides a Vermont Senate seat), the country might be able to find its way back from the brink.

Addendum: I penned this on my laptop Thursday afternoon, while alligator watching in a local nature preserve. I wasn’t able to access the full dataset on partisan bent and inflation expectations in order to determine, definitively, if we truly are living in unprecedented times in terms of how party affiliation is affecting consumers’ views on prices. Hopefully, I’ll be able to obtain the data later this evening. If so, I’ll pen a separate article over the holiday. Irrespective of what any historical time series shows, I think the analysis presented above is incisive, informative and generally representative of the fractious environment in which we’re all forced to toil.