The Build Back Better Act’s macroeconomic boost looks more valuable by the day

In previous work, Adam Hersh highlighted how the Infrastructure Investment and Jobs Act (IIJA) and the Build Back Better Act (BBBA) could provide a backstop against the possibility that economic growth slows due to slack in aggregate demand for goods and services in the next couple of years. Over the past few months, a pronounced uptick in inflation convinced far too many that the U.S. economy actually faced the opposite problem of macroeconomic overheating—an excess of aggregate demand.

But late last week, the Bureau of Economic Analysis (BEA) released data making it clear that the U.S. economy is not overheating and that aggregate demand support in 2022 and 2023 could be vital to continued economic growth. Given this, the macroeconomic boost provided by the BBBA in coming years could be valuable indeed.

In this post, I argue:

  • The U.S. economy is demonstrably not overheating due to excess fiscal stimulus from earlier this year. In fact, deficient demand is as likely to be a constraint on economic growth going forward as constrained supply.
  • The inflationary uptick in the spring and summer was driven by a sudden reallocation of spending, not a macroeconomic imbalance of overall aggregate demand and supply. In addition to this sharp reallocation of spending, sectoral supply-side bottlenecks also contributed to pushing up inflation.
  • U.S. households would not be better off today had policymakers passed less fiscal relief earlier in 2021. The unexpected reallocation of spending, combined with supply-side bottlenecks, did contribute to the inflationary uptick in mid-year. This inflationary burst did, in turn, keep some of the full potential value of the fiscal relief from reaching households. But inflation-adjusted personal income for U.S. households is unambiguously higher due to the relief measures, and jobs and wage growth are better due to the stimulus provided.
  • The data on gross domestic product (GDP) in the third quarter of 2021 released late last week show that the main source of inflationary pressurethe sharp reallocation of spending—is completely gone. The rapid run-up in spending on goods this past year reversed in the third quarter and contracted sharply. Going forward, if policymakers enact more-contractionary macroeconomic policy measures—either cutting back fiscal relief and recovery efforts or raising interest rates—they will commit a bad mistake, slowing growth in 2022 notably and halting the welcome rapid recovery that had been underway.

Below, I expand on each of these points.

The U.S. macroeconomy is not overheating due to “too much” fiscal relief and recovery provided earlier in 2021. The evidence for this can be seen in Figure A below showing actual GDP and potential GDP over the past few years. As of the third quarter of 2021, actual GDP remained below what the Congressional Budget Office (CBO) estimated potential GDP would be in this quarter. In short, given the productive capacity that existed pre-COVID, the U.S. economy should be easily capable of producing as much GDP as was produced in the third quarter of 2021 without causing any inflationary pressures.

Aggregate demand not excessive relative to pre-pandemic capacity: Actual and potential GDP in $billions, 2017–present

Year Potential Actual
2017Q1 $18,209.5 $17,896.6
2017Q2 $18,284.5 $17,996.8
2017Q3 $18,362.1 $18,126.2
2017Q4 $18,441.6 $18,296.7
2018Q1 $18,523.9 $18,436.3
2018Q2 $18,609.6 $18,590.0
2018Q3 $18,698.1 $18,679.6
2018Q4 $18,787.9 $18,721.3
2019Q1 $18,879.0 $18,833.2
2019Q2 $18,971.4 $18,982.5
2019Q3 $19,064.1 $19,112.7
2019Q4 $19,157.1 $19,202.3
2020Q1 $19,250.2 $18,952.0
2020Q2 $19,340.2 $17,258.2
2020Q3 $19,424.2 $18,560.8
2020Q4 $19,512.0 $18,767.8
2021Q1 $19,602.5 $19,055.7
2021Q2 $19,697.4 $19,368.3
2021Q3 $19,795.8 $19,465.2
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The data below can be saved or copied directly into Excel.