- Economists like Larry Summers are worried the Biden fiscal stimulus plans will result in runaway inflation.
- Both the COVID relief package and the infrastructure stimulus will not result in high inflation.
- There’s no reason to fear overheating of the economy.
- Dan Alpert is an adjunct professor at Cornell Law School and a founding managing partner of the New York investment bank Westwood Capital LLC.
- This is an opinion column. The thoughts expressed are those of the author.
- Visit the Business section of Insider for more stories.
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!
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!
While the $1.9 trillion American Rescue Plan and the administration’s upcoming $2.0 trillion infrastructure expansion, repair and replacement program will pump an ocean of spending into the economy, given the structure of the US economy – as described in my column yesterday – we will see quite a bit of that spending leak abroad with no material impact on domestic inflation. More about that below.
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.