Want to out yourself as a Democrat? Say that you’re worried about inflation. Partisan preference has always shaped how individuals view the health of the economy. But party affiliation is now a critical bellwether for inflation expectations as well, and the consequences of the growing political divide could scramble how Federal Reserve policymakers work to keep surging prices in check. Republicans generally expected higher inflation than Democrats throughout President Joe Biden’s presidency, according to the University of Michigan’s monthly consumer sentiment survey. Still, from mid-2021 on, members of both parties said they thought prices would climb faster than the Federal Reserve’s annual target of 2 percent. After Donald Trump won his second term, year-ahead inflation expectations for Republicans plummeted — dropping to just 0.1 percent in January, per Michigan’s latest survey — while Democrats said they thought prices would climb by a whopping 4.2 percent. “It's disturbing because it's not a polarization of philosophy, it’s polarization of the perception of the facts — which is a more dangerous thing,” said David Kelly, the Chief Global Strategist at JPMorgan Asset Management. “For many years, we've known that people's perception of the economy was dependent on their party affiliation, but I must say this is the most dramatic swing that I've seen in terms of people's expectations on inflation.” The Commerce Department will provide its monthly inflation update at 8:30 a.m. The consensus estimate among economists is that prices climbed at an annual rate of 2.8 percent in December, excluding food and energy costs. Why does this matter?: Inflation expectations can be self-fulfilling. If the public believes prices are going to rise, they’ll spend more money now to get more bang for their buck. Businesses respond to stronger demand by raising prices. Higher prices — particularly during periods of low unemployment — can lead workers to ask their employers for better wages so they can keep up with rising costs. But the reverse is also true. If expectations are anchored at-or-below the Fed’s inflation target, it will reduce the likelihood that prices will soar. Fed Chair Jerome Powell cited Michigan’s consumer sentiment survey as a major reason why the central bank moved ahead with jumbo rate hikes when inflation was spiking in mid-2022. According to Joanne Hsu, who oversees the UMich survey, the divergence between Democrats and Republicans reflects a divide over how Trump’s plan to impose high tariffs on imports — possibly as soon as Saturday — will hit their pocketbooks. Democrats say they will drive up the cost of large purchases like cars and durable goods. Republicans say Trump’s agenda will bring down prices. Critically, the policies that Democrats “are worried about don’t even need to be implemented for inflation to become a problem,” Hsu told MM. “It doesn’t matter if these partisan differences are rational or not, it matters if they start acting on it through their spending behavior.” Why does it matter, pt. II: The growing divide between Democrats and Republicans could also mean that future inflationary shocks could have disparate effects depending on regions. “If you’re looking at just the median, or just the average inflation expectation, you might be missing a lot,” Carola Conces Binder, an economics professor at the University of Texas at Austin, told MM. Binder published research alongside Indiana University’s Rupal Kamdar and the University of Notre Dame’s Jane Ryngaert last year suggesting that Republicans’ unanchored inflation expectations during the Biden administration contributed to higher prices in parts of the country where the GOP is dominant. “What the Fed can do to keep expectations anchored is somewhat limited, because expectations are now so dependent on politics,” Binder told MM. “Central bank speeches and announcements won’t matter as much to consumer expectations as their political beliefs,” she added. “That makes it especially important that the Fed keep inflation steady or close to target.” It’s FRIDAY — And your host is already thinking about how busy next week will be. The “debanking” hearing, the jobs report, maybe tariffs? What will drive economic policy and markets next month?. Let me know what you’re thinking and what I should be writing about. I’m at ssutton@politico.com.
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