It’s Time to Be Worried About Inflation
President Biden and the Fed shouldn’t be surprised to see that inflation concerns are mounting. The president’s excessive budget spending proposals and the Fed’s ultra-loose monetary policy have been inviting inflation for months.
In his first 100 days in office, Biden has come up with three enormous budget proposals with an estimated total cost of almost $6 trillion, or close to 30 percent of GDP. First, he rushed through Congress a $1.9 trillion American Rescue Plan stimulus package. Now he is proposing an American Jobs Plan aimed at improving the country’s infrastructure and an American Families Plan to address social issues, each with price tags of close to $2 trillion.
And Biden has been doing all of this at a time that the Federal Reserve still has as loose a monetary policy as it can and there is a large amount of pent-up demand in the economy.
It should have come as no surprise, then, that the recent data released by the Department of Labor indicated a 4.2 percent spike in consumer prices compared to a year ago—double the Fed’s 2 percent inflation target. Richard H. Clarida, the vice chairman of the Fed, dismissed that shocking inflation print as just “one data point.” And so it was. But it all too likely was also an indication that the Fed has been too slow to respond to the Biden budget stimulus at a time that the economy was already strongly recovering.
The Fed should have been wary that the amount of fiscal stimulus passed by Congress and the White House this year greatly exceeded the amount of stimulus that the economy needed. The American Rescue Plan, together with the December 2020 bipartisan stimulus package, will pump budget stimulus into the economy equivalent to about 13 percent of GDP. Yet according to the Congressional Budget Office, the country’s output gap—that is, difference between the current level of output and what it could be with full employment—is only 3 percent.
Yet the excessive budget stimulus is only part of the policy stimulus that the economy is receiving. The Fed has allowed the broad money supply to grow by 30 percent—by far its fastest pace in the past 60 years. As if that were not enough, the great degree of pent-up demand built up during the lockdown will likely be released as the economy returns to normal.
No wonder prices are going up. Whatever the merits of Biden’s most recent public spending proposals may be, the last thing that the economy needs now is more unfunded government spending. Yet that is precisely what he is proposing.
Whereas the American Jobs Plan envisages close to a $2 trillion increase in public spending over the next eight years, it calls for collecting the revenues to finance that expenditure over a 15-year period. This implies that over the next decade, the Jobs Plan would add an estimated $1 trillion to the country’s public debt.
The way in which Biden plans to finance his Families Plan could also add to long-run inflationary pressure. While he proposes financing this spending plan through tax increases, he has made clear that this will not involve any tax increase on those earning less than $400,000 a year. He has also argued that taxing the wealthy will not change their spending habits. Yet if taxing the wealthy does not change their spending habits, it means that there also will not be any offset to the increase in aggregate demand associated with the increased public spending. That too will put upward pressure on prices.
Beyond adding to immediate inflationary pressure, Biden’s budget proposals will complicate the Federal Reserve’s task of keeping inflation in check over the longer run by substantially increasing the size of the public debt. Even before Biden’s budget proposals, the Congressional Budget Office estimated that the U.S. public debt would rise to almost 110 percent of GDP by 2030—a higher level than prevailed immediately after World War II. After Biden’s budget proposals, that figure will be even higher.
As the public debt rises, the Fed’s ability to fight inflation will become increasingly constrained. It is bound to come under tremendous political pressure not to raise interest rates to fight inflation, since higher interest rates would increase the government’s debt servicing costs and limit the room for other government expenditures.
In the same address to Congress in which he announced the Jobs Plan and Families Plan, Biden signaled his openness to negotiation and compromise. A key focus of any such negotiation between the White House and Congress should be reducing the price tags of Biden’s new spending proposals. Otherwise, we should expect to see a lot more inflationary “data points” for the foreseeable future.