Inflation is falling, but the next president could boost it again

Inflation is as good as dead – unless the next president brings it back to life.

Both Vice President Kamala Harris and former President Donald Trump are pushing economic policy ideas that, regardless of their merits, could lead to higher prices for many goods and services, some economists say.

Harris has proposed expanding the child tax credit and wants to give some first-time home buyers $25,000 for their down payment.

Both measures would give new impetus to an economy that is already growing faster than its long-term potential.

Trump announces that he will abolish taxes on social benefits, remove millions of people from the labor market through the largest deportation of illegal immigrants in history, and impose new tariffs on all US imports.

These measures would drive up costs across the economy.

Investors view Trump as the bigger inflation risk, according to analysts at Macquarie Group, a global investment firm based in Sydney, Australia.

His policies could increase the annual inflation rate by a full percentage point, says Thierry Wizman, foreign exchange and interest rate strategist at Macquarie.

“There is still a perception among traders that Trump is more inflationary,” he said.

The former president's tax, tariff and immigration policies are likely to lead to faster price increases and higher interest rates in response, which in turn would increase the value of the US dollar, Macquarie told clients this week.

Recent developments in financial markets show that investors are reassessing the Democrats' prospects in November.

As Harris rose in the polls this month, traders who had expected Trump to defeat President Biden began to scale back their bets.

This has led to a loss in the value of the dollar of almost three percent, Macquarie said.

Karoline Leavitt, a spokeswoman for Trump's campaign, blamed the Biden administration's “reckless spending” for inflation and said “Trump's agenda would provide the needed fiscal relief.”

The candidates' competing proposals come as the Federal Reserve is expected to cut interest rates next month for the first time since March 2020 as it makes progress in fighting inflation.

Some say the risk is that the president's actions could lead to renewed price increases next year, just when prices are slowly starting to moderate.

In July, consumer prices rose 2.9 percent year-on-year, still above the Fed's 2 percent target but below their peak of over 9 percent in mid-2022.

“We should be very cautious about taking any action that could further exacerbate inflationary pressures. And there are certainly a number of actions proposed by both Vice President Harris and President Trump that could risk renewed inflation,” said Marc Goldwein, senior policy director at the nonprofit Committee for a Responsible Federal Budget.

“We should be on guard.”

Both campaigns deny that their plans will raise prices. Harris has proposed raising the corporate tax rate to 28% from the current 21% and increasing taxes on the wealthy, which her campaign says will raise enough revenue to cover the costs of her plan.

It has also proposed measures to curb prices by increasing supply, including tax incentives for the construction of so-called “starter homes”.

Trump insists – contrary to popular economic opinion – that his tariffs are paid for by other countries. In fact, numerous studies conclude that US tariffs are paid for by Americans.

The Republican platform, largely written by him, promises to “end inflation” by expanding domestic energy supplies, reducing government regulations and curbing federal spending.

Harris said Trump's tariff plans would “drive prices up even further,” while Trump said inflation would “only get worse if she gets elected.”

Harris, who has only been a candidate for a month, has so far presented only an incomplete economic plan.

Their demand for tax breaks for the middle class and assistance for first-time home buyers would cost $1.7 trillion over 10 years, according to the CRFB.

Their other proposals to raise the minimum wage and eliminate the tip tax would cost another $100 to $200 billion.

About $1 trillion of that ten-year spending would be offset by her planned corporate tax increase, leaving a deficit of about $800 billion to $900 billion.

The Harris team announces that it wants to close this gap through further tax increases – including for top earners – as the Biden administration proposed this year.

However, Harris has also announced that she will propose new child care and long-term care initiatives, which Goldwein said could impact the bottom line.

He said it would be “premature” to reach a conclusion about the impact of the Harris plan on inflation before those details are available.

Inflation has been voters' biggest complaint over the past three years.

To bring this under control, the Fed raised interest rates eleven times starting in March 2022 – the fastest such campaign in decades.

Higher interest rates slowed the economy by making borrowed money more expensive for consumers and businesses.

At the same time, supply chains that had been overloaded during the pandemic began to function normally again.

The combination of lower demand and improved supply led to a decline in inflation.

But higher interest rates left their mark on the economy. The cost of a 30-year mortgage reached 8% at the end of 2023, almost double the average interest rate when the Fed began raising rates.

The number of monthly housing starts is currently one-third lower than when the interest rate increases began.

And new commercial and industrial lending has stagnated over the past 18 months.

Given the signs of a slowdown in the labor market, investors are now expecting the Fed to cut interest rates at its meeting on September 18.

The unemployment rate was 4.3% in July, compared to 3.5% a year earlier.

The only difference between the asset managers is the amount of the first share.

About 72 percent of investors expect the Fed to cut interest rates by a quarter of a percentage point, according to CME Fed Watch, an analyst tool for futures contracts.

About 28 percent expect a change of half a percentage point.

The Fed's expected move to cut interest rates will mark a new chapter for the economy and have consequences for average Americans and businesses.

Lower interest rates could provide relief to potential homebuyers who have been deterred by high mortgage rates or to businesses that have postponed their investment plans.

“There are companies waiting to potentially do something, but they need to see lower interest rates before they actually do it,” says Neil Dutta, head of economics at Renaissance Macro Research.

However, a sudden outbreak of activity is unlikely to occur immediately.

The markets have already priced in the Fed’s first step.

The average cost of a 30-year fixed-rate mortgage is 6.5 percent, down about half a percentage point since the beginning of July.

If the central bank cuts interest rates next month, it will likely continue to do so, Dutta said.

Economists at Goldman Sachs said Tuesday they expect the Fed to cut interest rates by a quarter of a percentage point at each of its next three meetings and lower its benchmark rate to a range of 4.5 to 4.75 percent by year-end.

Meanwhile, some economists fear that the economy's inflation problems have not yet been completely overcome.

Consumer spending remains stable. Layoffs are below pre-pandemic levels.

And gross domestic product grew 2.8 percent year-on-year in the second quarter, above the 1.8 percent mark that the Congressional Budget Office considers sustainable.

“I don't think inflation is really dead,” said economist Michael Strain of the American Enterprise Institute. “There's a very real chance that inflation will get stuck above 2.5 percent.”

This is also why some people are worried about the impact of the next government’s policies on prices.

“If inflation does not return to 2%, [and] If fiscal policy steps on the accelerator at the same time, that will certainly make the Fed's job more difficult,” says Torsten Slok, chief economist at Apollo Global Management.