Prices are rising rapidly, and elevated inflation is likely to remain through at least the next year. Congress shouldn’t make matters worse by signing a $4 trillion check for President Biden’s economic plan, which Democratic leaders are looking to push through even without Republican support.
The payments to households and other spending on social programs that the plan calls for would increase demand at a time when it is already strong. More demand in the face of limited supply would increase inflationary pressures, threatening the longevity of the current economic expansion.
Relative to the same month the year before, inflation as measured by the Consumer Price Index clocked in at 5.4 percent in June, 5 percent in May and 4.2 percent in April. The Federal Reserve’s preferred measure of inflation points to slower price increases — 3.9 percent in May — but those are still well above the Fed’s target of 2 percent.
Of course, the reopening of the economy is a one-time event, and a good chunk of June’s inflation reading came from increases for hotels, rental cars and airfares. Car prices continued to surge, driven by a shortage of computer chips. These temporary factors account for around half of the month’s price increase.
But if around half of the increase is caused by temporary factors, that means half can’t be readily explained by them. Rapid price increases that aren’t clearly linked to pandemic-related causes are troubling. The longer they last, the more worrisome they become.
Consumers, investors and businesses seem to think that inflation will remain high. Consumers say they expect prices to rise 4.8 percent over the next 12 months, according to a recent University of Michigan survey. As measured by the bond market, investors currently expect around 2.5 percent inflation over the next five years, up considerably from around 1.6 percent before the pandemic. And a survey last month from the National Federation of Independent Business found that a net 47 percent of companies are increasing average selling prices, up seven percentage points from May and the highest share in four decades.
Because expectations about future inflation can become self-fulfilling — with workers demanding higher wages and suppliers charging higher prices today in expectation of higher prices in the future — these trends are troubling. We are likely to see elevated inflation until at least 2023.
Nonetheless, President Biden and congressional Democrats want to spend $3.5 trillion over 10 years on social programs, education, expanding Medicare and other health programs as well as policies to counteract climate change. This spending would be in addition to the nearly $2 trillion for economic relief and stimulus already this year. On top of that, a bipartisan group of senators is hoping to spend around $600 billion on roads, bridges, ports, water systems, the power grid and expanding broadband access.
There are good reasons to believe this bipartisan infrastructure spending won’t be inflationary. Its focus is on improving longer-term productivity, not near-term demand. By strengthening the supply side of the economy, it would ease inflationary pressures. In addition, the spending would be spread out over a decade, and would likely add very little to the deficit until 2024.
The $3.5 trillion plan is another story. Though the details of this package are still being debated, Moody’s Analytics calculates that the plan would contain more than $500 billion in tax credits from 2022 to 2026 for low- and middle-income households. Such payments would increase consumer demand for goods and services, pushing up their prices.
For that five-year period, Moody’s also expects more than $400 billion of spending on social programs like nutrition and housing assistance, child care and education. Much of this would add to inflationary pressures.
Overall, even though taxes would go up under the Democrats’ plan, it would add nearly $1 trillion to the deficit over the five years beginning in 2022, according to Moody’s. Given the composition of much of this deficit spending, this would be another big boost to the demand side of the economy.
Economists can’t say for sure whether the inflationary pressures caused by this spending would push the economy into a damaging inflationary period. Regardless, it would increase the risk of a policy mistake by the Federal Reserve. In the face of another multi-trillion-dollar spending package and consistently disquieting monthly inflation numbers, the Fed might feel it had fallen behind the curve and attempt to withdraw some support for the economy, decreasing or eliminating asset purchases or raising interest rates.
But the Fed may not have the necessary precision to slow the economy without putting it into reverse. Prematurely ending the expansion would hurt low-wage workers and low-income households the most, threatening to leave them out of the recovery.
The top goal for economic policy should be to keep the current expansion going as long as possible so that all workers and households can benefit from it. Congress shouldn’t put the expansion at risk with another enormous spending bill.
Michael R. Strain (@MichaelRStrain) is a senior fellow and the director of economic policy studies at the American Enterprise Institute.
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