What happens in the economy now will have a big — perhaps a decisive — impact on the presidential election and control of Congress in 2024.
To a remarkable degree, the economy is what voters care about, so much so that a long-standing election model relies on economic data to make accurate predictions without considering the candidates’ identities, personalities, popularity or policies or the strategies and policies messages at all or dirty tricks of their campaigns.
Currently, this model, created and run by Ray Fair, a Yale economist, shows that the 2024 national election is very winnable.
According to Professor Fair’s forecasts, the economy is strong enough for incumbent Democrats to win the popular vote for the presidency and Congress next year. But it’s not a slam dunk. The model shows that persistent – albeit declining – inflation also gives Republicans a reasonable chance of victory. Both results are within the error tolerance of the model.
This means that small changes in the economy could have a big impact on the next election. That could put the Federal Reserve in crisis, even if the central bank tries to avoid it.
The Fed strives for independence. But the decisions policymakers make over the next 12 months could potentially decide the election.
The fair model
Professor Fair’s groundbreaking US electoral model follows something that was quite radical when he developed it in the 1970s.
It analyzes politics without actually delving into politics.
Instead, Professor Fair focuses on economic growth, inflation and unemployment. With a few tweaks over the years, he uses economics to analyze elections since 1978, using data for elections going back to 1916.
He found that the economy determines the climate for national elections. The candidates and the political parties have to live in it.
Professor Fair makes his econometric models available as a teaching tool on his website.
“I encourage people to incorporate their own assumptions and see how that changes the outcome,” he said.
Professor Fair doesn’t even attempt to predict the final election results. For starters, he doesn’t do state-by-state tallies or Electoral College projections, nor does he examine the potential impact of third- or fourth-party candidacies.
What his model does brilliantly, however, is provide a standardized, historically informed framework for understanding the economic impact on the popular vote for America’s two major political parties.
The model shows that surprisingly strong economic growth and low unemployment since the start of the Biden presidency have already significantly helped incumbents, while uncomfortably high inflation rates over that period have helped Republicans. Based on the history embedded in the model, there is room for a decisive change in the popular vote if these critical economic factors change. But probably not much space.
The inflation effect
Last week Wall Street was jubilant about the positive news about inflation. The overall consumer price index for October fell to an annual 3.2 percent from 3.7 percent the previous month – and from a high in this economic cycle of 9.1 percent in June 2022. At the same time, core inflation, which excludes fuel and food prices, rose. fell to 4 percent in October, the smallest increase since September 2021.
Inflation is still well above the Fed’s 2 percent target but is falling, and traders expect Fed officials will not need to raise interest rates at least at their next meeting in December. And there is more.
The Wall Street consensus, which is also captured by the futures market, is that more encouraging inflation news is to come and that the Fed will begin cutting rates by spring. The sooner the Fed acts, this thinking goes, the more likely it is that a significant rise in unemployment – and a full-blown recession – can be avoided.
There are political implications.
Because interest rate cuts have a delayed impact on the economy, the sooner such cuts occur, the more likely the economy is to experience a boost before next year’s elections. An increase in economic growth in the first nine months of an election year – without a rise in unemployment – would help the incumbent president’s party, Professor Fair’s model shows. (If Republicans controlled the White House now, strong economic growth would help them more than Democrats, history, and the Fair Model suggest.)
On the other hand, a decline in inflation won’t help Democrats much at this point, said Professor Fair, because high inflation has already been factored into the election forecast – and probably into the minds of voters. The model averages the first 15 quarters – or 45 months – of a presidential administration, and we are already in the 11th quarter of the Biden presidency.
For the overall inflation effect to reduce significantly, actual sustained deflation – a sustained fall in prices – is required in the coming months. Historically, this only happened during major economic downturns that were accompanied by increases in unemployment, as was the case during the Great Depression. A severe recession would likely mean a Democratic debacle next year.
A looming nightmare
However, a major recession in the next 12 months is not the general view among economists or in financial markets.
Instead, a more favorable outlook beckons. The likelihood of a “soft landing” – a decline in inflation without a recession – has increased, according to most forecasters.
But the timing is difficult for the political outlook and for the Fed.
A growth spurt that is not accompanied by a sharp rise in unemployment would help the incumbent party, and large interest rate cuts by the Fed could well lead to more economic growth. But the Fed will be reluctant to start cutting interest rates while inflation is still above 3 percent. Instead, the Fed has vowed to keep interest rates “higher for an extended period,” and has already done so while inflation is high.
Short-term interest rates have been above 5.25 percent since July, mortgage rates are still above 7.5 percent, and consumer borrowing is constrained. The longer this continues, the greater the likelihood of catastrophe in the financial system. But if the Fed cuts interest rates too soon and triggers another wave of inflation, the damage to its already tarnished reputation as an effective inflation fighter would be severe.
So the Fed is in a tough spot.
If the central bank doesn’t start cutting rates by the summer, it may be unwilling to do so at all in the fall, as this would inevitably be perceived as a partisan stance.
As Ian Shepherdson, chief economist at research firm Pantheon Macroeconomics, said in an online discussion, “a lot depends on the timing” of inflation data in the coming weeks. If the inflation problem isn’t resolved soon, he said, we will have to deal with “the nightmare of whether the Fed wants to initiate a change in the policy cycle as the election approaches.”
Sitting presidents always want the economy to look good on Election Day. The only well-documented case in which a president pressured the chairman of the Federal Reserve to lower interest rates—and the central bank did so—involved Presidents Richard M. Nixon and Arthur F. Burns in late 1971 and 1972. Mr. Nixon did not limit his improper actions to intimidating the Fed. There was also the Watergate break-in at the Democratic National Committee headquarters and the subsequent cover-up. An investigation exposed the secret White House recording system that recorded Mr. Nixon’s rough treatment of Mr. Burns.
But there is substantial evidence that presidents and their appointees have tried unsuccessfully to influence the Fed in other cases as well. President Donald J. Trump has repeatedly criticized current Fed Chairman Jerome H. Powell for not cutting interest rates enough. President Lyndon B. Johnson bullied William McChesney Martin to the point of physically abusing him. And Paul Volcker revealed that James Baker, President Ronald Reagan’s chief of staff, told Mr. Volcker that the president wanted to “give you an order”: Don’t raise interest rates as the 1984 election approached. Mr. Volcker said Mr. Reagan watched in silence.
In an oral history, Mr. Volcker said the meeting took place in the White House library rather than the Oval Office, probably to protect the president. “Whatever recording devices they had, they probably weren’t in the library,” Mr. Volcker said. “I didn’t want to say we were going to raise rates,” Mr. Volcker recalled, “because we weren’t that close, as far as I can remember, so I didn’t say anything.”
Mr. Powell said he viewed Mr. Volcker as a role model. Mr. Volcker was generous and forthcoming in private conversations, but he was sometimes silent in public. It will be wise to emulate this restraint at critical moments in the coming months.
The Fed needs to be seen as independent and tough and suppressing inflation like Mr. Volcker has done. Then it will most likely have to cut interest rates dramatically to stimulate the economy.
The calendar may not cooperate. The tougher the Fed is now, the more delicate its position will become as the election approaches.
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