Not So Hot Anti-Inflation Talk

Eakinomics: Not So Hot Anti-Inflation Talk

Reflecting its sensitivity over the inflation created by the $2.9 trillion American Rescue Plan, the White House pushed back on the further inflationary impacts of its American Family Plan (the foundation of the so-called “reconciliation bill” being developed by Congress), publishing a blog post by White House economists Jared Bernstein and Ernie Tedeschi. The post makes two arguments, one regarding the long-run productivity effects of its hard and “human” infrastructure proposals, and the other the near-term stimulus impacts of the spending. The former looks like wishful thinking, while the latter misapplies the standard framework.

AAF has taken a close look at the notion of spending trillions on hard, productive infrastructure. The analysis indicates that infrastructure does have productivity impacts, but these are most likely overshadowed by the negative impacts of the tax increases proposed to finance them. (Elsewhere, recall that the Congressional Budget Office stressed the virtues of paying for infrastructure by cutting non-investment spending.) Similarly, it is nice to hope that paid leave, child care subsidies, child tax credits, health insurance subsidies, home health spending, and the other taxpayer dollars in the American Family Plan will increase labor force participation. Unfortunately, the data suggest this supply-side expansion looks like a risky bet at best.

The second point is that one has to spend the money to make the investments, and more spending can be stimulative and inflationary. The conventional (Keynesian) analysis goes like this: (1) the government runs a larger deficit by spending more or taxing less, (2) the larger deficit produces more spending either directly or via households, and (3) the change in the deficit produces more economic activity. (You can run the logic in reverse for smaller deficits, which is one reason the left never wants to cut the deficit.)

Notice that there are two key transmission issue​s. First, the larger deficit has to turn into spending. This was hardly the case in the spring of 2020, when the huge fiscal response to the pandemic drove the saving rate over 30 percent, and again after the December 2020 stimulus produced a saving rate in excess of 20 percent. In those cases, the spending occurred when the saving got run down in subsequent months. Second, the spending has to increase output and income. But that means the increased demand has to (nearly automatically) be matched by increased supply. That might make sense recovering from a traditional 20^th century recession, but the argument is completely misplaced in the midst of a supply-driven pandemic recession or (going forward) when the economy is back at full employment.

Indeed, according to the President’s Budget​, the administration is assuming that the unemployment rate is down to 4.1 percent by next year, so full employment is the right working assumption. The Budget’s policies produce additional deficits of 0.5 percent, 0.4 percent, and 0.2 percent (for a cumulative 1.1 percent) of gross domestic product (GDP) in 2022, 2023, and 2024. That’s assuming it gets all the tax increases that it proposed. If not, the spending impacts are 1.3 percent, 1.0 percent, and 0.3 percent of GDP (cumulative 2.6 percent) in those years. So, suppose we take the authors’ argument at face value: We will see demand increases corresponding to those fiscal impulses, but since the economy will be at full employment output cannot rise and the excessive stimulus will put upward pressure on prices.

That is inflationary.