Inflation, Deficits, and AI: The New Democratic Congress Faces Three Economic Tests

President Donald Trump campaigned on the premise that a Democratic sweep of Congress would trigger a 1929 style depression, but the results of the November election have produced a divided government instead. The new Democratic majority in the House and Senate now faces a mandate from voters to address the inflation that has eroded middle class purchasing power. Trump stated he is prepared to cooperate with the new congressional leadership, though his historical record suggests a preference for confrontation.

The economic backdrop is mixed. A report released this week showed that employers added 165,000 jobs, and the unemployment rate fell to 4.1%. Despite these figures, consumer price inflation remains high at 3.7% annually. This rate has been driven by Trump tariffs and the war in Iran, which began in February. The Federal Reserve, which has struggled to hit its 2% inflation target for nearly six years, may now have more room to lower interest rates without political interference.

Douglas Holtz-Eakin, an economist and president of the American Action Forum, identified the Federal Reserve as a surprise winner of the election. With Democrats controlling the Senate, they can block Trump from filling potential vacancies on the Fed board. This dynamic removes pressure on Fed Chair Kevin Warsh to pursue aggressive inflation cuts. However, the administration argues that energy costs will drop once the war in Iran concludes, a timeline Trump has yet to define.

The federal budget deficit presents a second major challenge. The U.S. government is accumulating debt at a rate of approximately $2 trillion per year. Interest payments on this national debt now exceed $1 billion annually and have surpassed military spending. Treasury Secretary Scott Bessent and White House Budget Director Russell Vought are working on a fiscal consolidation plan to be revealed after the election. This plan likely involves a combination of tax increases and spending cuts, particularly targeting Medicare costs.

A third issue involves the role of artificial intelligence in the economy. Jason Furman, an economist at Harvard University, describes the current AI investment boom as comparable only to the railroad expansion of the 19th century. Data from Furman's Econvitals tool shows an 80.6% increase in data center construction over the past year, while spending on housing, schools, and factories has declined. The stock market sold off last week on fears that Democrats might regulate the sector, but the technology remains a key driver of economic demand.

Finally, the new Senate must address the solvency of Social Security. The program is projected to exhaust its funds by the end of 2032, at which point benefit payments could fall by nearly 25 percent. Senator Elizabeth Warren of Massachusetts is collaborating with Republican Senator Bernie Moreno of Ohio on a bipartisan proposal to raise the payroll tax cap. Because Social Security reform cannot pass through the reconciliation process, it requires a bipartisan majority to overcome potential vetoes and secure passage.