Midterm Elections, Affordability and the Fed

Still six months out, the U.S. midterm elections are likely to influence government initiatives to deal with higher energy costs. Our Head of Public Policy Research Ariana Salvatore and Global Chief Economist Seth Carpenter discuss how the Congress and the Fed might react.Read more insights from Morgan Stanley.----- Transcript -----Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Head of Public Policy Research for Morgan Stanley.Seth Carpenter: And I'm Seth Carpenter, the firm's Global Chief Economist and Head of Macro Research.Ariana Salvatore: Today we're discussing the run up to the midterm elections and what it could mean for the macro outlook and policy response.It's Wednesday, April 29th at 10am in New York.Last week, Mike Zezas and I talked through the midterm elections and their potential consequences for the economy and markets. This week we figured it might be helpful to talk about the setup into November, especially as we're both increasingly being asked about the macro outlook and potential for targeted stimulus to offset the oil shock.So, Seth, let's start there. we know cost of living is a key issue in elections, and we've seen a pretty meaningful oil shock feed through markets. How are you thinking about that in the context of the broader economy?Seth Carpenter:  Our U.S. economics team has estimated that the higher gas prices that we have now and likely to have for the rest of the year are going to be more than enough to offset any boost to consumer spending from the higher tax refunds this year. So, I think that's the first point.If you're expecting a boost to come through that channel, you probably want to unwind that. And In fact, overall, what we've done is lowered our forecast for U.S. growth by about three or four tenths of percentage point worth of growth this year because of the higher energy prices. So, it's a drag on spending, I think, no matter how you cut it.Ariana Salvatore: And that's not happening in isolation, right?Seth Carpenter: No, that's exactly right. That's exactly right. We've also got at least somewhat restrictive monetary policy layered on top. So, financial conditions are already a little bit tight and the oil price shock sort of amplifies that tightening by weighing on spending. That's going to be really important.I think an extra complication then is what does it do to inflation? For now, we don't think it's going to be that big of a deal. History says at least looking at the data that when energy prices go up, when oil prices go up, gasoline prices go up. It does boost headline inflation for sure, but the pass through to core inflation is pretty limited, and the effects tend to go away on their own without too much time.So, I think the real hit here is going to be from the higher costs acting like a drag on consumer spending.Ariana Salvatore: Right. And importantly, it's a very visible shock. Gasoline prices feed directly into how consumers and voters perceive the economy, which brings us into the political overlay as we approach the midterms…Seth Carpenter: Yeah, I think that's exactly right. And whenever we economists are thinking about inflation and prices and consumers, we think about exactly that – what we call salience, just how visible are these prices. And gasoline prices tend to be some of those prices that stick out in people's minds.So, if people are seeing it. And people are reacting to it, give me some idea of what the Congress can realistically do between now and the midterm elections.Ariana Salvatore: Well, I would say in theory there's a range of options. Direct stimulus, targeted transfers. We tend to frame affordability policies across five vectors: energy, healthcare, housing, consumer credit and trade policy. But in practice, the constraints are pretty binding right now and as we've been saying, tariff policy is really the only lever the president can pull easily to have a real impact on voters.Seth Carpenter: All right. So, you said constraints and constraints for the Congress. Can you walk us through what those constraints are?Ariana Salvatore: Sure. So, the first and most obvious is deficits. We're already running large fiscal deficits in the U.S., and I would say there's limited political appetite to expand them meaningfully from here in the near term, especially heading into an election.The second is procedure. If you want to pass something sizable, you're either