November 17, 2021
We’re getting a lot of “I told you so’s” on inflation in recent days. Yesterday, it was Larry Summers in the Washington Post, today we get Steven Rattner in a New York Times column. Their story is that the 6.4 percent year-over-year inflation shown in the October CPI proves that their warnings about Biden’s recovery package being too large were correct.
Before analyzing this claim and Rattner’s takeaways going forward, let me clearly say that I did not anticipate this sort of price jump. While some increase in inflation was inevitable, and even desirable, the rise was considerably more than I expected. I attribute this to supply chain issues, which are almost certain to be temporary (more on this later). But I am happy to acknowledge that this burst of inflation did catch me by surprise.
So, let’s get to Rattner’s story. He and Summers argued that the American Recovery Package (ARP) that Congress passed in February overstimulated the economy, leading to a serious problem with inflation. They want the Fed to raise rates to slow the economy, saying that its wait and see attitude is irresponsible and will lead to more inflation. Rattner also wants the Democrats to cut back their Build Back Better plan to make sure that it does not increase the deficit.
Okay, so starting with the basic claim, clearly the ARP did give a big boost to the recovery. That is why the unemployment rate is down to 4.6 percent, a level that we didn’t reach following the Great Recession until February of 2017, more than nine years after the start of the recession.
But, it is hard to blame the ARP as the sole cause of the spike in inflation. The UK just reported its year-over-year inflation rate as 4.2 percent, far above its central bank’s 2.0 percent target. The reason this is a big deal is that the UK didn’t have a big stimulus package and its central bank has been far more vigilant in its commitment to low inflation than the Fed. While 4.2 percent is obviously less than 6.4 percent, the jump in the UK shows that there is something more than an over-stimulated economy driving these inflation numbers.
There are a couple of other things that don’t fit well with the Summers-Rattner line. Contrary to what Summers very explicitly predicted, the dollar has not fallen against other major currencies, it actually has risen substantially since the start of the year. It’s up by more than 6.0 percent against the euro.
This means both that investors are not anxious to dump the dollar as inflation erodes its value, but also that we can buy lots of imported goods more cheaply from Europe and other places, insofar as both our inflation exceeded theirs and also the dollar has risen in value against their currencies. That would be an important check on inflation going forward.
The other point here is that the financial markets clearly are not buying the Summers-Rattner hyperinflation story. The interest rate on the 10-year Treasury bond is currently 1.63 percent. It’s hard to believe investors would accept this sort of interest rate if they anticipated 4-5 percent annual inflation. (By comparison, it never got below 4.0 percent in budget surplus Clinton 1990s.) The breakeven 10-year Treasury rate (comparing the rate on Treasury bonds and inflation-indexed bonds) is 2.7 percent.
As someone who warned about both the stock bubble in the 1990s and the housing bubble in the 00s, I am well aware that financial markets can be seriously wrong. Nonetheless, it is worth noting that they clearly do not accept the Summers-Rattner inflation story.
Demand Pressure Going Forward
While we can debate forever whether the ARP put too much money into the economy in the spring and summer, the relevant question is what the economy looks like going forward. On this front, there are good reasons for thinking that our problem may be too little demand rather than too much demand.
First and most importantly, we ended the special pandemic unemployment insurance (UI) programs and $300 weekly supplements in September. At the time, we had almost 9 million people getting benefits under the pandemic programs, as well as 3 million people getting convention UI in various forms. The loss of these benefits would conservatively amount to roughly $280 billion (1.2 percent of GDP) on an annual basis.
In addition, various other pandemic programs are coming to an end. The funds in the Paycheck Protection Program have mostly been disbursed. The eviction moratorium came to an end in September, which will lead to evictions in some cases and more rent payments in others. The moratorium on student loan payments ends in January, which will also be a drag on the spending of millions of people with debts.
All of these factors will be a drag on the economy moving forward. In addition, there are some inevitable sources of drag due to one-time actions. The pace of mortgage refinancing has slowed sharply, largely because this is the sort of thing people only do once. There is a lot of money generated from these fees. If the costs of refinancing a $250,000 mortgage are 2 percent, that comes to $5,000 in fees and commissions that we won’t be seeing as the pace slows. Also, we won’t be seeing additional money freed up for consumption by families that are able to refinance at lower rates.
There is a similar story with homebuying. There had been a big surge at the start of the pandemic as people took advantage of increased opportunities to work from home and move to new houses. This switch will continue, but at a much slower pace going forward. It is important to remember that people moving to new homes often buy new refrigerators, washers and dryers, and other items currently seeing rapid price increases.
These factors will be serious drags on the economy going forward. They are not likely to tip us into recession, but they should make us hesitant to accept the inflation hawks’ complaints that the economy is overstimulated.
It is also worth mentioning that the supply chain problems will likely work themselves out in the next several months. Decreased demand for a wide range of household items, coupled with shippers innovating and hiring more workers, should get things back to something like normal some time next year. This will mean falling prices in many areas. We already see this with the price of televisions, which has dropped 2.8 percent in the last two months after rising rapidly over the summer.
Should We Trim Build Back Better?
The bottom line from Rattner is that we need to start worrying about budget deficits big time. If we are not likely to see much inflationary pressure going forward, this is not clear, but it’s also important to get some idea of the magnitude involved. Most of the Build Back Better (BBB) plan is paid for with tax increases, but let’s say that we have a shortfall of $300 billion. That comes to $30 billion a year over the course of a decade, or roughly 0.1 percent of GDP in a $30 trillion economy.
There is no plausible story in which this sort of shortfall will have a noticeable impact on inflation. Furthermore, as has been widely pointed out, many aspects of the program will lower inflation, such as increasing parents’ ability to work with increased childcare, as well as improved access to broadband and better infrastructure.
It is also worth mentioning an inflation-debt issue that the deficit hawks persist in ignoring. The government grants patent and copyright monopolies every year that lead to higher prices for everything from prescription drugs to computer software and video games. These monopolies both stimulate economic activity (that is their point) and effectively create debt in the form of higher prices. In the case of prescription drugs alone, we are likely paying an additional $400 billion a year due to patent monopolies and related protections.
The insistence on ignoring the impact of these government-granted monopolies in their calculations of deficits and debt shows the lack of seriousness of the deficit hawks. How is it any different from the standpoint of the macroeconomy if we increase the deficit by $50 billion by spending more on biomedical research, as opposed to stimulating another $50 billion in spending by the pharmaceutical industry through more generous patent monopolies?
The fact that they never even consider the issue shows a profound lack of seriousness. Anyhow, we do need to be concerned about the risks that we are overheating the economy and creating real problems of inflation going forward. But, in spite of the victory lap from the deficit hawks, there is good reason to believe that they are not correct and that Congress and the Biden administration should proceed as planned with the BBB.