It’s time to worry about inflation
President Biden and the Fed shouldn’t be surprised that inflation fears are mounting. The president’s excessive budget spending proposals and the Fed’s ultra-loose monetary policy have been pushing for inflation for months.
In his first 100 days in office, Biden presented three huge budget proposals with a total estimated cost of nearly $ 6 trillion, or nearly 30% of GDP. First, he rushed a $ 1.9 trillion US stimulus package through Congress. Now he’s proposing a U.S. jobs plan to improve the country’s infrastructure and a U.S. plan for families to tackle social problems, each with price tags of nearly $ 2 trillion.
And Biden has done all of this at a time when the Federal Reserve still has as loose a monetary policy as possible and there is a large amount of pent-up demand in the economy.
It should therefore not have been surprising that recent data released by the Ministry of Labor indicates a 4.2 percent surge in consumer prices from a year ago, double the Fed’s 2% inflation target. Richard H. Clarida, vice chairman of the Fed, dismissed this shocking impression of inflation as just “a data point.” And so it was. But it’s too likely that this also indicates that the Fed has been too slow to respond to Biden’s fiscal stimulus at a time when the economy is already recovering strongly.
The Fed should have been wary of the fact that the amount of fiscal stimulus passed by Congress and the White House this year far exceeded the amount of stimulus the economy needed. The US bailout, along with the bipartisan stimulus package of December 2020, will inject fiscal stimulus into the economy equivalent to around 13% of GDP. Yet, according to the Congressional Budget Office, the country’s output gap – that is, the difference between the current level of output and what it could be with full employment – is only 3 percent. hundred.
Yet excessive fiscal stimulus is only part of the political stimulus the economy is receiving. The Fed has allowed the broad money supply to grow by 30% – by far its fastest pace in 60 years. As if that weren’t enough, the high degree of pent-up demand accumulated during the lockdown will likely be released when the economy returns to normal.
No wonder the prices are going up. Whatever the merits of Biden’s latest public spending proposals, the last thing the economy needs now is more unfunded public spending. Yet that is precisely what he is proposing.
While the U.S. Jobs Plan envisions a nearly $ 2 trillion increase in government spending over the next eight years, it calls for raising the revenue to fund that spending over a 15-year period. This implies that over the next decade, the jobs plan would add about $ 1 trillion to the country’s public debt.
The way Biden plans to fund his plan for families could also worsen inflationary pressures in the long run. While he proposes to fund this spending plan through tax increases, he has made it clear that this will not result in any tax increase for those earning less than $ 400,000 a year. He also argued that taxing the rich would not change their spending habits. Yet if taxing the rich does not change their spending habits, it means that there will also be no compensation for the increase in aggregate demand associated with the increase in public spending. This will also put upward pressure on prices.
Beyond adding immediate inflationary pressure, Biden’s budget proposals will make it harder for the Federal Reserve to bring long-term inflation under control by dramatically increasing the amount of government debt. Even before Biden’s budget proposals, the Congressional Budget Office estimated that U.S. public debt would reach nearly 110 percent of GDP by 2030 – a higher level than immediately after World War II. After Biden’s budget proposals, that figure will be even higher.
As public debt increases, the Fed’s ability to fight inflation will be increasingly limited. It is bound to come under enormous political pressure not to raise interest rates to fight inflation, as higher interest rates would increase the costs of servicing the government’s debt and limit room for maneuver. for other government spending.
In the same speech to Congress in which he announced the Jobs Plan and the Family Plan, Biden signaled his openness to negotiation and compromise. A key goal of any such negotiation between the White House and Congress should be to lower the price tags of Biden’s new spending proposals. Otherwise, we should expect to see many more inflationary “data points” for the foreseeable future.