Political paralysis in the United States likely – also a problem for Europe?

After the midterm elections in the U.S., there is hardly any time to take a deep breath on the political level. For now speculation will begin as to which of the Democrats and Republicans will enter the race for what will probably be another controversial presidential election in two years’ time. Although the midterm elections may strengthen the more moderate forces in both parties somewhat, society remains divided on many issues. This means political uncertainty at a time when the U.S. economy is likely to slip into recession or at least a slowdown in growth with rising unemployment. With inflation still high and only slowly declining, the Fed has little choice but to continue to raise interest rates sharply. If inflation does not come down faster than generally expected, interest rates will probably rise from today’s four percent to around five percent. The more restrictive monetary policy will slow down the U.S. economy until the presidential elections in November 2024, which is likely to hurt the Democrats in particular as the party of the incumbent.

Fiscal policy, on the other hand, is likely to be much more passive. The opportunity for Biden to boost the cooling economy by increasing spending will probably be limited. The Republicans will probably try to put the brakes on Joe Biden’s plans, which is likely to paralyze political activity to some extent. In view of the arguably too extensive and inflation-driving fiscal packages during the pandemic, a more passive fiscal policy can certainly be viewed positively from a macroeconomic perspective. However, there is also a downside: a recession without a simultaneous fiscal stimulus will make the economic situation more difficult for many people and the election campaign even more heated than is already to be expected. There is also a risk that the regularly scheduled increases in the debt ceiling for the federal budget will once again become the plaything of party interests, increasing the risk of default.

The political paralysis and the two years until the uncertain outcome of the U.S. presidential election come at an inopportune time for the European economies. They are already being jolted by the energy crisis, dramatically high inflation and the cooled global economy. All in all, the U.S. economy is less affected by these factors, and it has also digested the pandemic-related economic slump better than the euro zone. For example, U.S. economic output returned to the pre-crisis level of late 2019 as early as the early summer of 2021, whereas this was not the case in the euro area until the end of 2021 and in Germany, for example, until the summer of 2022.

In addition to all the other burdens on the European economies, there is now uncertainty about the political course of the United States after the upcoming presidential elections – for example, with regard to the future of transatlantic trade relations, support for climate policy goals or the military umbrella for Europe. Such uncertainties could, for example, reduce companies’ propensity to invest and further dampen the already gloomy economic outlook. However, the threat of weak economic development makes it more difficult in Europe to finance the energy turnaround or infrastructure renewal. In the USA, too, investment is needed in the energy turnaround and infrastructure; under Joe Biden, the US government has already made substantial financial resources available for this in the coming years. Against this backdrop, the looming political paralysis until the presidential elections is manageable for the USA in terms of economic policy. Or to paraphrase an old saying of former U.S. Treasury Secretary John Connally from 1971: While the upcoming presidential elections are extremely important, especially for the U.S. itself, they will also be a major problem for Europe because of their great significance and the uncertainties surrounding the outcome.

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