Senate Minority Leader Mitch McConnell is siding with an unlikely ally as he rails against President Joe Biden’s spending plans: former Treasury Secretary Larry Summers.
The senator from Kentucky gave Summers “kudos” on Monday for “predicting” the now-elevated rate of inflation. Price growth accelerated in May to its fastest one-year pace since 2008 as massive demand butts heads with supply-chain issues and widespread shortages. Republicans recently doubled down on their worries around rising inflation and blamed the Biden administration for fueling such risk.
McConnell echoed such sentiments during a Monday press conference and invoked Summers as a harbinger of the price surge.
“He predicted we would have raging inflation, and that is, in fact, what we are grappling with today,” the Minority Leader said.
Summers, who served as President Bill Clinton’s Treasury Secretary and as director of the National Economic Council for President Barack Obama, has spent much of 2021 railing against the Biden administration and the Federal Reserve for their policy stances. He criticized Democrats and Republicans in March for passing the “least responsible” fiscal policy of the last 40 years, adding both parties were creating “enormous” risks.
Just last week, the former Treasury Secretary warned the US could see inflation “pretty close” to 5% by the end of the year.
Other Republican lawmakers have seized on Summers’ words, using them as ammo with which to slam Biden’s economic agenda. Mentions of rising prices have become commonplace at GOP press conferences, and a late May memo urged party members to refer to inflation as “Democrats’ hidden tax on the Middle Class.”
Yet Republicans have frequently cited products’ year-over-year price gains as proof of overwhelming inflation, an inherently skewed comparison as it refers back to price declines seen at the start of the pandemic. The early 2020 readings now make for a lower bar to clear and boost year-over-year readings.
Summers’ remarks also directly conflict with the outlook held by the Biden administration and the Fed. The “overwhelming consensus” is that inflation will “pop up a little bit” before fading to healthy levels, Biden said Thursday. Fed Chair Jerome Powell on June 16 repeated his expectation that inflation will prove to be “transitory” as bottlenecks were addressed.
Early signs suggest Powell’s forecast is correct. Prices of used cars, industrial metals, and lumber all cooled through early June, signaling broad inflation could soon slow to less concerning rates.
The deficit-spending debate rages on
McConnell also knocked Democrats’ proposals to spend trillions of dollars more on infrastructure and family support programs. Passing a “portion” of Biden’s original infrastructure plan makes sense, but approving both of his follow-up plans would be “wildly out of proportion to what the country needs,” McConnell said.
“The pandemic is, essentially, in the rearview mirror. To continue to borrow and spend at this level is completely unacceptable for the future of this country,” he added.
The push for fiscal austerity contrasts with May comments from Treasury Secretary Janet Yellen. With the Fed set to hold rates near zero well into the future, the government should spend on support programs before debt becomes a bigger burden, she said.
“We’re in a good fiscal position. Interest rates are historically low… and it’s likely they’ll stay that way into the future,” Yellen said. “I believe that we should pay for these historic investments. There will be a big return.”
Maximum employment. Full employment. They may seem to be similar phrases, but they are dramatically different, in ways that could shape the US economy long after the pandemic ends.
After decades of adhering to an agreed-upon employment threshold called full employment, the Federal Reserve is trying a new playbook. In August, the central bank replaced this goal with “maximum employment” as part of a new policy framework.
Whereas the previous target sought to minimize deviations when employment was too high or low, the Fed now aims to “eliminate shortfalls of employment from its maximum level,” Governor Lael Brainard said in February.
Put another way, the central bank will push for a labor market that doesn’t just feature low unemployment, but also inclusivity and healthy wage growth. The new mandate sounds encouraging. But to achieve it, the Fed is entering uncharted territory.
How much unemployment can you have with low inflation?
The previous threshold for low employment rested on a concept known as the non-accelerating inflation rate of unemployment (NAIRU), which represents a level of unemployment at which inflation doesn’t spiral out of control. Though the true rate is unknown, the Congressional Budget Office estimated it stood at roughly 4.5% in 2020.
NAIRU served as a loose guide for the Fed as the US recovered from the Great Recession, but it didn’t quite work. The labor market’s recovery from the financial crisis was, and remains, the longest of any recovery since World War II.
Since the start of the coronavirus recession, Fed officials made it clear they weren’t going to use the same strategy. The Fed’s new framework seeks inflation that averages 2% over time. That opens the door to periods of stronger inflation.
Prematurely retracting monetary support can leave underserved communities hurting and set the US back for years, Fed Chair Jerome Powell said following the FOMC’s March meeting. By allowing for a brief period of elevated inflation, the central bank believes it can power a faster and more equitable labor market recovery.
“There was a time when there was a tight connection between unemployment and inflation. That time is long gone,” Powell said. “We had low unemployment in 2018 and 2019 and the beginning of ’20 without having troubling inflation at all.”
The maximum-employment experiment is uncharted territory
Despite Powell’s repeated messaging that stronger inflation will prove largely “transitory,” some economists slammed him for risking a dangerous inflationary spiral. Letting inflation run above 2%, they say, can spark a cycle of soaring prices that would cripple the still-recovering economy.
Keeping rates near zero into 2023 “seems to me at the edge of absurd,” Larry Summers, a former Treasury Secretary who has criticized the fiscal and monetary response to the pandemic, said at a May event hosted by CoinDesk.
“We used to have a Fed that reassured people that it would prevent inflation,” Summers said. “Now we have a Fed that reassures people that it won’t worry about inflation until it’s staggeringly self-evident.”
Higher inflation also tends to give way to higher wages, but rising pay might not benefit the economy as some hope. Fed analysis of how stimulus checks were spent suggests most additional income would mostly go toward paying debts and boosting savings, with only a fraction going toward spending.
Even the target for maximum employment isn’t entirely clear, as an unusually large number of Americans likely stopped working for good during the pandemic. A “significant” number of retirees skews estimates of the labor force’s size, Powell said in a Wednesday press conference. This effect “should wear off in a few years” as retirees are replaced with new workers, he added. Maximum participation will likely cloudy until then, whenever that is.
The unusually large jump in retirements through the pandemic could still give way to a stronger labor market, as was seen in the years before the health crisis, Randal Quarles, vice chairman for supervision, said in late May. Still, with uncertainties abound, the Fed may need to issue “additional public communications” about its progress targets and broader goal of maximum employment, he added.
That means maximum employment, while a worthy goal in many ways, carries more than inflation risks. It could be a cloudy and uncertain destination even for top policymakers.
The past seven days has been the toughest stretch yet for Bidenomics – the product of President Joe Biden’s ambitious effort to slash entrenched economic inequalities through major spending on infrastructure, childcare, clean energy, education, and cash benefits.
The lackluster April jobs report fueled Republican criticism of a labor shortage, prompting at least 17 red states to announce they will start pulling out of federal unemployment programs in June. Then a sharp rise in inflation heightened concerns that consumer demand is outpacing supply in various economic sectors, pushing prices up for goods like used cars, airline tickets, and recreational activities.
Meanwhile, a gas shortage is pummeling many Americans in the southeast just ahead of Memorial Day, following a cyberattack shutting down an important pipeline that supplies fuel to the East Coast.
Yet the White House says it’s not getting knocked off course as it pursues $4 trillion in new federal initiatives to overhaul the economy, with Republicans stepping up their attacks.
“We have consistently shared our expectations that inflation would rise, and we’ve also stressed why we thought that would occur,” a White House official who spoke on condition of anonymity told Insider. “No one expected it would be smooth or easy to reopen our economy, and we have anticipated disruptions as we slowly work towards the recovery.”
“I think the president’s team deserves criticism for not diagnosing the problems correctly,” Douglas Holtz-Eakin, a former economic aide to President George W. Bush, told Insider.
Holtz-Eakin said “demand is outstripping supply” and cited shortages of materials like computer chips. He added a related issue is that fewer Americans are in the workforce, arguing federal unemployment benefits are “part of that story, not all of it.”
This supply-demand imbalance has led to soaring prices, especially for used cars. “Inflation is always a supply issue,” Holtz-Eakin said. “To simply throw more money at it is not a solution.”
‘The trend is our friend’
Biden advisors argue the economy is demonstrating signs of healthy progress after a year of crushing restrictions, unemployment, and business closures. Despite April’s big jobs miss of just over 266,000 jobs regained, they say 500,000 jobs have been created on average in the past three months.
“We’re making good progress,” Cecilia Rouse, chair of the Council of Economic Advisors, said at a news conference on Friday. “However we must keep in mind that an economy will not heal instantaneously. It takes several weeks for people to get full immunity from vaccinations, and even more time for those left jobless from the pandemic to find and start a suitable job. Supply chains have been disrupted and sectors hardest hit are just beginning to come back.”
“The trend is our friend, moving steadily in the right direction,” White House economist Jared Bernstein told Bloomberg on Tuesday.
Many economists cautioned against misinterpreting the 4.2% rise in consumer prices last month – the largest monthly increase since 2008 – given it was measured from a year earlier. Prices plummeted in April 2020 as businesses closed their doors and people sharply cut their spending, so the resulting increase appears larger which many experts had been forecasting.
But former Treasury Secretary Lawrence Summers, who has consistently criticized the scale of Biden’s spending, is not one of them. “I was on the worried side about inflation and it’s all moved much faster, much sooner than I had predicted,” Summers told Bloomberg. “That has to make us nervous going forward.”
Federal Reserve chair Jerome Powell said he expects inflation to subside later in the year.
Despite the recent tremors, Democrats remain confident that they will be able to secure passage of Biden’s economic proposals, financed with tax hikes on high-earning Americans and large firms.
“It’s way too early to say that this job recovery won’t continue robustly,” Rep. Don Beyer of Virginia, chair of the Joint Economic Committee in Congress, said in an interview. “I believe it’ll take until August that we get a House bill over to the Senate that’s dealing with the potential tax increases, so there’s still a lot of time to figure out what’s happening in the economy.”
The first is a $2.3 trillion spending plan devoted to highways and roads, in-home elder care, domestic manufacturing and clean energy. The other is a $1.8 trillion package focused on cash payments for families, free community college, affordable childcare, and paid family and medical leave.
Beyer said “there isn’t any anxiety about the spending plans” among Democrats he’s spoken to, though they’re open to a deal with the GOP that would likely diminish the size of a package.
“Politics is the art of the possible. We’re not going to be angry at a President Biden who ends up finding a compromise ground that 10 Republicans can live with,” he said, referring to the number of GOP votes in the Senate that Democrats need for a proposal to clear the evenly-divided chamber.
Biden could strike a spending deal with Republicans
The White House is in the midst of negotiating with Republicans on the $2.3 trillion package known as the American Jobs Plan. With Senate Minority Leader Mitch McConnell’s stamp of approval, Sen. Shelley Moore Capito of West Virginia is steering the talks on the Republican side with an initial $568 billion offer. Only a third of it is new federal spending.
On Thursday, Biden described it as “a genuine effort,” and added “I think we can get there” as a two-hour meeting with Capito and a group of Republicans got underway.
“It was a very positive meeting,” Capito told Fox News on Friday. “We’re going to go back to the president early next week with another offer that, in light of the conversation that we had, trying to seek that bipartisan agreement.”
Both parties remain far apart on the price tag of a plan and even defining what makes up infrastructure. Republicans are pushing to constrain it to only physical transportation and communications, while Democrats want to include robust safety net spending on childcare and education.
The White House is walking a tightrope when it comes to pushing a potential deal through a 50-50 Senate and narrow House majority. Many Democrats are calling for a large infrastructure package with large new investments, given their full control of Washington’s levers of power.
They are also wary of dragging out negotiations when they have the ability to approve a wide range of the spending plans in reconciliation, a tactic to approve a budgetary bill with a simple 51-vote majority in the Senate.
Sen. Ron Wyden of Oregon, who heads the Senate Finance Committee, is kicking off infrastructure hearings later this month. He said there’s “a lot more work to do to climb out of the deep economic hole the pandemic created.”
“Control of both chambers of Congress and the presidency is rare, and it’s critical that Democrats do all we can with this opportunity to make real progress for the American people,” Wyden said in a statement to Insider. “While it would be our hope that we can do much of what the president outlined on a bipartisan basis, it’s much more important to get things done for the American people.”
The Biden administration spent much of its first days in office testing how further stimulus might drive inflation higher. No modeled scenario saw price growth surge out of control, The New York Times reported on Wednesday.
Still, the report said repeatedly that White House and Treasury officials are “worried” about the issue.
The inflation debate has loomed large over the White House since before President Joe Biden was even inaugurated. The president unveiled a $1.9 trillion relief proposal in January, pitching the plan as an additional boost for the US economic recovery. Largely Democrat-affiliated economists have fiercely debated the inflation risks of such large deficit-financed spending, led by former Obama- and Clinton-administration official Larry Summers.
Democrats largely backed the measure, saying the risks of retracting government support were greater than the risks of spending too much. But Republicans – and even some moderate Democrats – balked at the hefty price tag and cited fears that another set of stimulus checks could spark a dangerous surge in inflation.
“This is the least responsible fiscal macroeconomic policy we’ve had for the last 40 years,” Summers said in a March interview with Bloomberg TV, adding the measures are a product of “intransigence” among Democrats and “irresponsible behavior” among Republicans.
Democrats went ahead without any Republican votes, passing the bill via reconciliation, and Biden signed it into law on March 11. Still, the stimulus push wasn’t without some trepidation. A handful of officials in the Treasury Department spent several months modeling how Americans would deploy new fiscal support, and whether any outcome could lead to stifling inflation, according to The Times. Treasury Secretary and former Federal Reserve Chair Janet Yellen even helped create the models.
Their observations were encouraging and lend new support to Biden’s latest spending proposal. The team tested a range of potentialities for how quickly Americans would spend stimulus, where they would deploy cash, and how the labor market’s recovery would affect inflation. Yet no outcome saw inflation charge out of the Fed’s control and risk a new recession, the Times reported.
The findings have been hinted at in statements from the White House and the Treasury in recent weeks. Long-term scarring in the labor market poses a greater risk than inflation, Yellen told ABC’s “This Week” in March. Economic reopening is expected to drive a jump in prices, but the effects will likely be temporary and fail to drive sustained inflation, she added.
The administration’s Council of Economic Advisors mirrored Yellen in a Monday blog post. A temporary rise in inflation is consistent with trends seen after other major events like wars or past labor-market rebounds, economists Ernie Tedeschi and Jared Bernstein said. The White House will continue to monitor consumer prices, but it expects inflation to fade as actual price growth “runs more in line with longer-run expectations,” they added.
Fed Chair Jerome Powell has repeatedly backed up such an outlook. The central bank chief said last month that the Fed will “be patient” in monitoring inflation and eventually lifting interest rates. The most likely scenario during the recovery is that prices move higher but fail to stay elevated as the country enters a new sense of normalcy, Powell said in early March.
Although the Fed operates independently from the executive branch and doesn’t play a role in fiscal spending, officials testing inflation scenarios told the Times that the Biden administration trusts the Fed to intervene and stave off price growth should it accelerate faster than expected.
The latest data signals the country is far from any sort of inflation scare. The Consumer Price Index – a popular gauge of overall inflation – rose 0.6% in March as stimulus, reopening, and vaccination fueled stronger economic activity. Economists expected a 0.5% gain.
Consumer prices rose 2.6% year-over-year, also exceeding estimates. The measure is skewed somewhat by year-ago data, since prices initially dropped when the pandemic first slammed the US economy. Those readings present a lower bar for year-over-year inflation. Though the data points to stronger inflation, price growth still has a ways to go before it trends at the Fed’s above-2% level and warrants serious concern.
That opening paves the way for additional spending. Biden unveiled a $2.3 trillion infrastructure proposal late last month that includes funds for nationwide broadband, improved roads and bridges, and affordable housing. The package is expected to be spent over eight years, compared to the weeks-long rollout seen with much of Biden’s stimulus plan. Such long-term deployment would present little inflationary risk, and Biden has portrayed the plan as an investment in American industry, jobs, and research as opposed to an emergency relief measure.
The March uptick in inflation, however, does signal that price growth is trending higher. Future CPI readings are set to be closely watched releases as the administration balances its spending goals with a red-hot economy. Economists and officials are anticipating stronger inflation. How price growth trends from there will determine whether the Biden administration was successful or created new risks.
Forget the pandemic. Inflation is the new issue haunting Americans, on Wall Street and Main Street alike.
Celebrations over vaccine approvals and falling COVID-19 case counts are giving way to concerns over just how quickly the economy will recover – and what that means for prices.
New stimulus signed earlier this month promises to send hundreds of billions of dollars directly to Americans and supercharge consumer spending. And shortly afterward, the central bank underscored that it will support a strong recovery this year, as the Federal Reserve reiterated that it plans to maintain ultra-easy financing conditions at least through next year.
The potent combination of monetary and fiscal support has many fearing a sharp jump in inflation. The eventual reopening of the US economy is expected to revive Americans’ pre-pandemic spending habits. Yet an overshoot of expected inflation could spark a cycle of increasingly strong price growth that leaves consumers with diminished buying power.
Worries of such an outcome are shared among both the investor class and the general public. Google searches for “inflation” surged to their highest level since at least 2008 last week, according to research by Deutsche Bank Managing Director Jim Reid. Dovish investors might highlight that similar spikes emerged after the financial crisis, but hawks can point to the unprecedented scale of pandemic-era relief for why today’s situation stands out, Reid said in a note to clients.
“Whether or not inflation ever materializes there is a rational reason why this time might be different. That’s reflected in the increased attention on inflation,” Reid added.
The theme that this time might be different was echoed by a UBS team led by Arend Kapteyn, who wrote in a March note that “pandemic price movements have been unusually large … and are historically difficult to model/predict.”
More recently, a survey from data firm CivicScience shows 42% of adults being “very concerned” about inflation, according to Axios. That compares to just 17% saying they’re “not at all concerned.”
Inflation worries investors more than Covid
Also, institutional investors are shifting their focus from the pandemic to the risk of rampant inflation. Higher-than-expected inflation is now the biggest tail risk among fund managers, according to a recent survey conducted by Bank of America, higher even than the pandemic itself. Snags to vaccine distribution fell from the top of the list to third place, while a potential bond-market tantrum was the second most-feared risk.
To be sure, younger Americans seem less perturbed. The gap in inflation expectations between the baby boomer generation and millennials is the widest its ever been, a team of Deutsche Bank economists led by Matthew Luzzetti wrote earlier this month.
The disparity is likely a product of vastly different circumstances, according to the team. Older investors lived through the “Great Inflation,” a period from the mid-1960s to the early 1980s during which inflation surged and forced interest rates to worrying highs.
Younger Americans have only known a quarter-century of inflation landing below the Federal Reserve’s 2% target, and millennial investors could have a massive influence on whether inflation expectations and real price growth trend higher as the economy reopens, the bank’s economists said.
“With memories of the Great Inflation possibly already lifting inflation expectations for older age groups today, a more material drift higher in expectations likely would require a lift from the younger age groups,” they added.
CivicScience’s newer data suggests that gap is quickly closing. More than half of respondents aged 18 to 24 said they’re “very concerned” about inflation, more than any other age group surveyed. By comparison, just 37% of Americans aged 55 and older said they’re “very concerned.”
Respondents aged 35 to 54 were still the most worried overall, with 48% saying they’re “very concerned” and 36% saying they’re “somewhat concerned,” according to CivicScience.
Kapteyn’s note for UBS highlighted that the conversation around inflation closely resembles the one following the Great Recession: “A decade ago, following the global financial crisis, we were having very similar conversations with clients as we are now.”
At that time, fears of a quick recovery fueling an inflation bubble were similarly strong, “but instead we wound up in secular stagnation,” the bank wrote, referencing the phrase made famous by prominent economist Larry Summers to describe prolonged low growth and low inflation.
This suggests that Americans’ worries about future price growth – including warnings from Summers himself – could starve the US economy of healthy growth and rehash the last decade’s plodding recovery.
Former US Treasury Secretary Larry Summers said that the country is seeing the “least responsible” macroeconomic policy of the past 40 years, resting the blame on lawmakers on both sides of the aisle.
Summers offered the negative economic forecast during an appearance on Bloomberg Television’s “Wall Street Week” on Friday. Summers has vocally criticized President Joe Biden’s recently signed $1.9 trillion COVID-19 relief package, saying it could overheat the economy.
“The [Federal Reserve] has stuck to its guns on no rate hikes for years and years and continuing to grow its balance sheet,” he told Bloomberg. “What is kindling is now igniting. I’m much more worried that we’ll have either inflation or a pretty dramatic fiscal-monetary collision.”
He added: “I think this is the least responsible macroeconomic policy we’ve had in the last 40 years. I think fundamentally, it’s driven by intransigence on the Democratic left and intransigence and completely unreasonable behavior on the whole of the Republican party.”
Summers, who served in Bill Clinton’s Cabinet and directed the National Economic Council in 2009 and 2010 under former President Barack Obama, argued that the country is “running enormous risks.” He said he believes there’s “a one-third chance that inflation will significantly accelerate over the next several years.”
He offered additional scenarios pertaining to the country’s economic outlook.
“There’s a one-third chance that we won’t see inflation, but that the reason we won’t see it is that the Fed hits the brakes hard, markets get very unstable, and the economy skids closer down to a recession,” he said. “I think there’s about a one third chance that the Fed and the Treasury will get what they’re hoping for and we’ll get rapid growth that will moderate in a non-inflationary way.”
He added: “There’s the real risk that macroeconomic policy will be destabilizing.”
For months, Summers has been sounding the alarm of inflation fears, writing an op-ed in The Washington Post in January where he wrote that Biden’s relief package could cause “inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability.”
While Summers praised the COVID-19 package’s “ambition” and its “rejection of austerity orthodoxy,” he stated that garnering legislative support for tax increases or spending reductions could prove to be difficult and might pose a “risk of inflation expectations rising sharply.”
Treasury Secretary Janet Yellen had a different perspective, encouraging robust stimulus measures.
“It’s a big package, but I think that we need to go big now, and that we can afford to go big,” Yellen told PBS NewsHour anchor Judy Woodruff in an interview shortly before the legislation was approved by the Senate.
Yellen has also repeatedly dismissed concerns of inflation. “I’ve spent many years studying inflation and worrying about inflation. And I can tell you we have the tools to deal with that risk if it materializes,” she told CNN in January.
The Biden administration has been vigilant about not repeating the legislative and political mistakes of the $787 billion American Recovery and Reinvestment Act of 2009, which was signed into law by former President Barack Obama in response to economic impacts of the Great Recession.
The stimulus measure, which was championed by Obama and congressional Democrats, became a political liability for the party in the 2010 midterm elections, which saw the GOP retake the House and make sweeping gains across the country.
White House Council of Economic Advisors chair Cecilia Rouse said on MSNBC’s “The Sunday Show with Jonathan Capehart” last week that not doing enough to help the economy would pose a bigger threat, especially as the country is working to end the COVID-19 pandemic.
“When one makes an economic investment, there are risks,” she said. “There is a risk that this [relief package] will overheat the economy and cause inflation. However, it’s really in our estimation that the risk of doing too little is actually greater the risk of doing too much.”
This is the second of my two columns addressing concerns surrounding the Biden administration’s plans to greatly increase the federal government’s role in the US economy in the form of large scale fiscal spending, both for COVID-related relief and additional economic stimulus. Yesterday’s column dealt with the problem of potential economic “leakage,” while today’s will focus on inflation. Enjoy!
Recently, prominent economists such as Larry Summers and Olivier Blanchard have raised alarms warning that the Biden administration’s stimulus plans will produce high levels of inflation.
Normally, I would dismiss this sort of alarmism from warmed-over small-government politicos who have wrongly warned about the inflationary impact of government deficits for 40 years as another attempt to shrink government and elevate the primacy of the private sector. But as the inflation debate has become heated among liberals, the economic waters have become unnecessarily muddied.
The short answer – to both economists and to markets – is stop worrying about the emergence of sustained inflation in the prices of goods and services. It is extremely unlikely to pose a problem, and should not be viewed as a reason for the Biden administration to curtail their ambitious spending plans…although for all the wrong reasons!
Yet the inflation concerns held by Summers, Blanchard, and others are rooted in two other issues:
The unprecedented spike in the personal savings rate during 2020. The amount that Americans have in their savings spiked for two reasons: the inability to spend discretionary income due to COVID-related shutdowns and the fiscal relief transferred to households under the CARES Act and related stimulus efforts. As shown in the below graph, households – in theory at least – are chockablock with spendable cash.
The size of the “Output Gap” – that is, the difference between actual GDP and potential GDP. Potential GDP is determined via estimates from the Congressional Budget Office (CBO) and is often subject to debate among forecasters. If actual GDP is running below potential, as is the situation now, then inflation will be very low as demand is nowhere near the capacity of the economy to fulfill demand. If the economy “runs hot” – that is exceeds its theoretical potential capacity – inflation is thought to accelerate. As shown on the below graph, the current output gap is only a few hundred billions of dollars, so critics of the trillions of dollars of fiscal spending being proposed by the Biden administration believe that such a large expenditure will not only close the output gap but overheat the economy and result in undesirable levels of inflation.
The output gap may be bigger than we think
But there are problems with both of these arguments. As for the output gap, we don’t really know the true non-inflationary rate of growth that the economy can absorb. During the years prior to the Great Recession – when the economy was running above its projected potential – core inflation remained in the range of 2.0% to 2.3%, not a level viewed by the Fed as concerning – then or today.
And since 2008 inflation has averaged well below 2.0%, so there would seem to be little concern today with core inflation at 1.3% year-over-year, as shown below.
Moreover, following the Great Recession, the economy’s potential trend was adjusted downwards by the CBO. The dotted green line in the above graph indicates the pre-2008 trendline, if the economy’s actual potential capacity is still close to that trend, then inflation is unlikely to show up even with more federal spending than is currently in the Biden proposals.
A one-time savings glut does not mean sustained inflation
With regard to the savings accumulated by households during 2020, I would be highly skeptical of its ability to produce sustained inflation, even if it drove up prices somewhat over 2021.
First, it is important to make a distinction between “reverse dis-saving” and actual savings. American middle-income households went into this crisis with – once again – high levels of credit card, student and automotive debt (even home mortgages were elevated, albeit not to 2008 levels as a percent of value).
To the extent that excess “savings” was used to reduce household debt reversing that process will require two things – a high level of consumer confidence to induce additional debt accumulation, and – well – jobs and household income levels that induce lenders to lend. The Fed reported this week that from the first through fourth quarter of 2020, consumer debt and home equity lines were paid down by a total of $70 billion, while households mortgaged their homes for an additional, presumably out of need rather than enthusiasm about consumption. And with respect to consumer enthusiasm, the Michigan Consumer Sentiment Index, was down again this month at 76.2, from 102 pre-pandemic. Household incomes are tenuous if you ignore federal transfers and consumer lenders don’t tend to lend to households making ends meet through government subsidies.
Second, these savings have not been accumulated in households with a high propensity to spend. It is clear from multiple data sources that the increased savings are concentrated among upper-income households which spend far less of their incomes.
There may well be some short-term price escalation as people seek services they have been deprived of the enjoyment of for a year or more. But as Steven Blitz, Chief US Economist at TSLombard, put it recently, “to those anticipating a big reopening-related surge in prices… perhaps the surge will be more evident in Michelin-starred restaurants than the local diner.”
And the sector that has done the most since the recession to keep inflation in the black – housing – is undergoing a major shakeout. Rents are under downward pressure in many cities as the millions of workers who have lost their jobs are unable to pay. My city of New York has seen rents plummet to 10-year lows, and some homeowners are under pressure to the extent of losses in employment.
Finally, the US economy’s leakage of demand, as I discussed yesterday, to foreign producers trying to market their enormous excess capacity (and unlikely to raise prices as a result) will block the US economy from enjoying the benefits of fiscal multipliers that would normally accompany increased spending. Ordinarily low multipliers would be bad, but in connection with worries about inflation, it’s “good.”
Although I believe – as I noted yesterday – that the US needs to take aggressive action to limit that leakage. But even if America were to follow the prescriptions I set forth, the likelihood that our production and supply networks will onshore production quickly enough to impact the spending proposed by the administration over the next several years, is somewhere between slim and none.
Again, that’s bad – but is yet another reason not to worry about runaway inflation.
Larry Summers, the former US treasury secretary who has reportedly advised President-elect Joe Biden, thinks $2,000 stimulus checks would be a “pretty serious mistake” that could overheat the US economy.
Congress approved a $2.3 trillion pandemic relief package containing $600 checks for struggling Americans on Monday. On Thursday, US President Donald Trump called for $2,000 checks instead, and he has refused to sign the bill. Democrats support these larger checks, and House Speaker Nancy Pelosi plans to hold a vote on them Monday.
Summers, who was treasury secretary at the end of Bill Clinton’s presidency and director of the National Economic Council at the start of Barack Obama’s administration, told Bloomberg it’d be better to have stimulus than not – but that promoting consumer spending through individual checks was the wrong way to keep the economy moving.
He said he was “not even sure I’m so enthusiastic about the $600 checks,” let alone $2,000 ones.
The bill “probably would pay out $200 billion to $250 billion a month for the next three months,” Summers said.
“The level of compensation is running about $30 billion a month below what we would have expected it would. GDP is running about 70 billion a month below what we would have expected it would … We have stimulus already, much more than filling out the hole,” he said.
“And given that lots of the hole is not from the fact that people don’t want to spend, but because they can’t spend – they can’t take a flight or go to a restaurant – I don’t necessarily think that the priority should be on promoting consumer spending beyond where we are now,” he said.
Handing $2,000 checks to Americans would be a “pretty serious mistake that would risk a temporary overheat,” he added.
“When you see the two extremes agreeing, you can almost be certain that something crazy is in the air,” Summers said, adding that when Sen. Bernie Sanders and Trump are aligned, it’s “time to run for cover.”