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Divided US government would shape recession response

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House Minority Leader Kevin McCarthy and his fellow Republicans are poised to take control of the House in the upcoming midterm elections.
Source: Drew Angerer/Getty Images

The U.S. federal government will have a harder time addressing an economic downturn if either chamber of Congress flips parties in the midterms.

Democrats are likely to hold the Senate in the November elections, while Republicans are poised to take control of the House of Representatives, according to an analysis of poll data by S&P Global Market Intelligence economists. The midterm elections come as the U.S. is entering an economic downturn, with Market Intelligence economists forecasting U.S. GDP will contract in 2023.

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President Joe Biden would have a tougher time passing any new legislation to support the economy through a divided Congress. The risk of government shutdowns and debt ceiling fights will also rise, said John Raines, principal global risks adviser and head of North America for Market Intelligence, and Lawrence Nelson, senior U.S. economist for Market Intelligence, in an Oct. 13 note.

"Policy gridlock would be almost certain, with a series of procedural and symbolic actions taken in the House to damage President Biden's popularity," Raines and Nelson said.

Still, political pressure might push Republicans to embrace bipartisan efforts to address any new crises.

"Under extreme circumstances, they might play ball," said Harry Holzer, professor at Georgetown University's McCourt School of Public Policy and former chief economist for the U.S. Labor Department.

Limited options for Democrats

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With limited legislative prospects, Biden could advance his agenda through executive orders and regulation, as he has done already by forgiving some student loan debt, Holzer said. The drawback of this approach is that changes can be challenged in court and future presidents can easily undo them.

Democrats would likely rally around the need to expand unemployment insurance but disagree about other relief measures in response to a recession, Holzer said. Progressives would likely push for large relief bills to make Supplemental Nutrition Assistance Program benefits more generous and possibly some kind of public job creation. Moderates might support some of those goals depending on the severity of the crisis.

Democrats are focusing on abortion rights in their midterm campaigning while also touting the benefits of economic policies like student debt relief and the Inflation Reduction Act.

Recession management, at least initially, typically runs mostly through the Federal Reserve, and Congress will get involved sometimes if the situation is bad enough, as with the Great Recession, said William Winecoff, associate professor and director of graduate studies for political science at Indiana University Bloomington.

The Fed is raising interest rates to tame soaring inflation, with a peak expected in 2023. Central bank officials have acknowledged those efforts are likely to slow economic growth and put millions of American out of work.

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The economy going into crisis would make the prospect of fiscal measures more likely but partisan gridlock would be a challenge to passing legislation. Political dysfunction can spook markets and deepen economic weaknesses in the near term, Winecoff said.

Republicans might play ball

House Republicans might find it in their interest to pass legislation or risk looking like obstructionists, Georgetown's Holzer said. Such was the case in 2020 when Republicans felt pressure to back popular relief bills in cooperation with Democrats as part of the response to the COVID-19-fueled downturn. Still, opposition to Democrats could prove too strong.

The ideology of the Republican party has evolved from pure conservative orthodoxy to incorporate more populist strains focused on white, working-class voters, which could motivate some Republican lawmakers to support recession relief efforts, Holzer said.

House Republican leader Kevin McCarthy in an interview with Punchbowl News signaled his desire to rein in government spending but added that he does not want a government spending fight early in the next session of Congress.

"People are going to want to see us accomplish things," McCarthy told Punchbowl News. "We don't want to get bogged down."

How policymakers respond to recessions often depends on the nature of the downturn that occurs, said Alisdair McKay, a senior research economist at the Federal Reserve Bank of Minneapolis. In recessions characterized by supply shocks where the economy cannot consume and invest as much, the focus of policymakers is to pull back demand to bring it in line with supply, as the Fed is doing now, McKay said.

Lame ducks

It is possible that the outgoing Congress passes more fiscal policy measures before the year is out, said Daniel Clifton, head of policy research at Strategas. Historically, when Congress is slated to become divided, lawmakers get more aggressive during the lame-duck session because bills become harder to pass under a split government, Clifton said. Republicans and Democrats could strike a compromise on issues like a tax break on research and development and the child tax credit in the lame-duck session, Clifton said.

Senate Majority Leader Chuck Schumer said the Senate should be ready for "an extremely, underline extremely, busy agenda in the last two months of this Congress," according to Politico.

However, investors might react negatively to more fiscal policy under the view that such laws would make the Fed's job harder. Alternatively, investors could cheer more fiscal policy if they think it is offsetting the central bank's slowing of the economy.

"There's a real chance here that you could have some sort of fiscal policy boost that gets done in the fourth quarter of this year and the market's not paying attention to it," Clifton said.