President Biden’s quest for $1.9 trillion in fiscal relief is raising warnings from prominent economists that he could generate the kind of out-of-control inflation not seen for decades.
Bill Dudley, former president of the Federal Reserve Bank of New York, was one of the first to sound the inflation alarm in December — before Biden announced his American Rescue Plan. Dudley cautioned in a Bloomberg op-ed that the combination of explosive post-pandemic demand and federal stimulus would form a “nasty” spike in inflation.
Dudley renewed those inflationary warnings on Wednesday, writing that consumer saving levels, which remain roughly 5 percentage points higher than pre-pandemic levels, and company cash on hand will lead to a surge in demand that misallocated supplies won’t be able to keep up with, suggesting that the Federal Reserve “might have to pull back on stimulus sooner and with greater force than anticipated to keep inflation in check.”
Harvard economist Larry Summers, who advised former President Barack Obama and was Treasury secretary under President Bill Clinton, separately warned of “inflationary pressures of a kind we have not seen in a generation” latent in Biden’s economic recovery proposal last week and was later defended by former International Monetary Fund chief Olivier Blanchard.
“Whereas the Obama stimulus was about half as large as the output shortfall, the proposed Biden stimulus is three times as large as the projected shortfall,” Summers wrote in the Washington Post. “Relative to the size of the gap being addressed, it is six times as large.”
Blanchard suggested that economic output would need to surge as much as 14% to accommodate the demand glut that would follow Biden’s proposal.
“It would take the unemployment rate very close to zero,” Blanchard wrote. “This would not be overheating; it would be starting a fire.”
A report from Oxford Economics suggests that fears of inflation aren’t uncalled for, but chief economist Gregory Daco stressed that the inflation would not lead to the dramatic overheating Summers, Dudley, and Blanchard fear. A significant chunk of the measured inflationary increase, as Dudley noted, will be “because prices plummeted during the initial states of the Covid crisis last year,” shifting the basis on which future inflation is evaluated.
The report projects that inflation will jump to roughly 2.7% year-on-year in the second quarter of 2021, but that elevated inflation will be “rather transitory.”
“Inflation should remain at 2% or above for about two years, which hasn’t happened since the Global Financial Crisis,” the report read. “With GDP growth returning to a more moderate pace of around 2.7% in 2022, inflation should slow to around 2%.”
Despite the potential for the highest inflation since the 2008 financial crisis, 2% inflation is the Federal Reserve’s annual target — a target it has consistently fallen short of for years.
“Will inflation surpass levels not seen before the financial crisis? Yes,” Daco tweeted Wednesday. “Will ‘warm’ inflation feel ‘hot’ relative to post-GFC? Yes. Will the US economy overheat? No.”
Will ??US #inflation firm in the coming months? Yes
Will inflation surpass levels not seen before the financial crisis? Yes
Will “warm” inflation feel “hot” relative to post-GFC? Yes
Will the US economy overheat? No pic.twitter.com/9pORWpq9IV
— Gregory Daco (@GregDaco) February 10, 2021
The American Enterprise Institute’s Stan Veuger was skeptical that the economy was on the brink of a significant inflationary event, arguing that former President Donald Trump’s Tax Cuts and Jobs Act expanded the deficit and increased potential demand during a period of very low unemployment without bumping inflation above the Federal Reserve’s target.
“I’m not super concerned about that. It strikes me as a weird concern, to be honest,” Veuger said. “The unemployment rate was much lower four years ago, when we passed TCJA, which added, more gradually, quite a bit to the deficit, and I don’t think we heard any of those concerns back then. So, I don’t know what kind of model people had in mind.”
