The biggest threat to the U.S. economy is policymakers

Something still feels off in this economy. It's booming in many respects, with a strong labor market, healthy corporate and household balance sheets, and a lot of consumption.

But some, like JPMorgan Chase CEO Jamie Dimon, are worried we're seeing the calm before the storm. There are signs things could get gnarly. Inflation is at a 40-year high, shelves are empty, real wages are shrinking and labor is in short supply.

Government and monetary policy will play an important role in how this works out, but those policies are also the biggest risk to U.S. growth going forward.

In their natural state, economies grow more than they shrink. Humans are remarkable for their ability to innovate and their desire to make their lives better. But growth isn't guaranteed. Many countries have adopted policies that undermined growth. In the early 20th century, for example, Argentina had the same GDP per capita as Canada; now Canada's per-capita GDP is more than five times Argentina's, in part because of the South American nation's feckless fiscal and monetary policies and decades of political instability following the Great Depression.

Haiti and the Dominican Republic's economic fortunes diverged after the 1960s. Rich countries have been fortunate to have the right policies - and some luck - that foster growth. Often policies will change after a big shock like the pandemic. Right now, the U.S. economy has a lot of potential, but much will depend on the policies public officials implement.

In the short run, policymakers need to do something about inflation. It was bad policy, in part, that brought about high inflation in the first place, including excessive stimulus in 2021. Then the Federal Reserve was too slow to respond.

When faced with inflation in the 20th century, the Fed repeatedly caused recessions by coming in too late and too hard. A mild recession may be unavoidable at this point because the Fed got so far behind the curve this time, too. How it manages rate increases in the next few years will determine the course of inflation and the severity of a downturn, if one occurs. The more the Fed miscalculates, the smaller the bull's eye gets: Raise rates too high and the economy contracts; don't go high enough and prices will keep rising and inject more uncertainty into markets - which can cause a recession, too.

Additional risks are coming from fiscal policy in Washington. President Joe Biden says his inflation strategy consists of letting the Fed do its job, fixing the supply chain bottlenecks and controlling deficits. (How he'll do the last is unclear, since higher taxes or big spending cuts can slow the economy.) There's a chance these policies could help the economy, depending on how they're executed. But price controls proposed by Sen. Elizabeth Warren, D-Mass., would only discourage production and create more shortages. Canceling student debt isn't going to do anything to help inflation, either.

Though a near-term recession would be painful, core aspects of the economy are robust enough that it shouldn't be too long or deep. Policies that could undermine longer-term growth are far more worrying. The desire to re-shore production and maintain the former administration's tariffs - or even add more - along with subsidies for domestic production translates to higher prices and less resiliency because there is less trade, which means fewer goods. It also makes U.S. industry less innovative and efficient since Americans don't need to compete as much with firms in other countries.

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Now add to all this the recent antitrust push. Traditionally, the government has gone after firms whose monopoly power harmed consumers. The new fashion is to target firms that get so big they crush any potential competition. Competition is good for growth, and there are legitimate concerns about unfair practices that regulation should address. But the problem with the new antitrust approach is that it often targets firms (at least in the rhetoric we've been hearing) simply for being large.

Big is not necessarily bad. In fact, a more global, tech-driven economy creates greater returns to scale and some bigness may be required. Bigger may be necessary in an economy where access to proprietary data and a lot of users is needed to make products better. Bigger can also mean lower costs. Shrinking American firms and depriving them of scale may be another strike against American competitiveness.

The U.S. economy remains among the most innovative and dynamic in the world. It's still a top destination for global talent and aspiring entrepreneurs. The enduring popularity of the dollar and dollar-dominated assets reflects an economy that is expected to keep growing. But past performance does not guarantee future growth.

The right policies can help dig us out of our current predicament, but after that, policymakers just need to get out of the way.

(COMMENT, BELOW)

Allison Schrager is a senior fellow at the Manhattan Institute and a contributing editor of City Journal.

Previously:
• Buck up, boomers. You're still better off than your parents
• How to manage the biggest risk of all: uncertainty
• Startup boom is the kind of risk-taking Americans need
• Gen Z is too compliant to achieve greatness
• A bigger child tax credit isn't the poverty solution we need
• Finding your power in a higher-priced world
• The Biden administration's plans to double the tax rate on capital gains will prove costly to all Americans, not just the wealthy
• WARNING: Feel Good Now --- Pay Later: Stimulus is crammed with goodies but makes no economic sense
• The 'Stakeholder' Fallacy: Joe Biden's vision of capitalism is a recipe for failure