Fiscal Policy and Inflation: The Impact of the U.S. Relief Program and Its Significance for the “Better Rebuild Act”

Fiscal Policy and Inflation: The Impact of the U.S. Relief Program and Its Significance for the “Better Rebuild Act”


Inflation has exceeded many people’s expectations earlier this year. Although there are many good reasons to believe that it will start to slow down and enter a more normal range in early 2022, rather than continue to spiral upward, it turns out that it is more stubborn than many people (at least I) expected.

This raises two key questions: Does rising inflation mean that criticism of the American Rescue Program (ARP) has been proven to be correct, as has often been claimed recently? Does this mean that the “Better Rebuild Act” (BBBA) currently being debated should be shelved and/or reduced in scale?

The answers to these questions are “basically not” and “absolutely not.”

Recalling the American Rescue Plan Debate

As early as February and March, center left critic ARP claim It is too big and will cause inflation. These critics made a very specific quantitative argument: Output gap-According to estimates by the Congressional Budget Office (CBO)-only –4% by the end of 2020, ARP will provide more than twice the fiscal stimulus, causing the output gap to quickly turn from negative to positive, triggering inflation. The output gap is essentially an indicator that aggregate demand (household, business, and government expenditure) lags behind the economy’s potential production capacity.More specifically, the output gap is Actual Gross Domestic Product (GDP) and Potential GDP-If the economy operates with the labor market close to the “natural unemployment rate,” then the Potential GDP is what the CBO estimates can generate.

In turn, the natural unemployment rate is the lowest unemployment rate consistent with non-accelerating inflation. In theory, if the unemployment rate is lower than this natural rate for a long time, then empowered workers will push wages high enough to impose increasing upward pressure on prices. Therefore, if labor is fully utilized in a sustainable (ie non-inflationary) way, the potential GDP is what the economy can generate. When real GDP is below this potential, it means that aggregate demand is too weak and needs to be boosted. The main claim of ARP critics is that given the size of the output gap in early 2021, the boost provided by the plan is too great.

This is a perfectly reasonable argument.Measured output gap used to be The possible fiscal stimulus is much smaller than that of ARP.I think the overall argument is a bit Too easy At the time, but it made sense. Its main advantage is that it provides a clear and undisputed empirical test that allows us to check in the future whether their scenario of the reasons for the acceleration of inflation has actually been realized.

So, did you do it?

no.Using the latest estimated potential GDP (from July 2021), the output gap in the third quarter of 2021 Stay negative (Approximately –1.7%), even if inflation has risen sharply. This is just a fact.

If ARP critics are wrong about the rapid reversal of the output gap from negative to positive, then why is inflation accelerating?The very short answer is “COVID-19 has never disappeared.” This Longer answer It is the continued existence of COVID-19 that makes consumer spending highly biased towards goods and away from face-to-face services, even if the overall GDP recovers quickly, and COVID-19 has closed ports and shipping facilities around the world, seriously putting pressure on the supply chain .

It can be said that the output gap In the commodity field The rapid change from negative to positive is this an important driver of inflation that we are seeing? Yes! But this is not an argument put forward by ARP critics.If they say, “By the end of 2020, consumer spending will be extremely commodity-biased. Even if vaccination is relatively widespread, at least in the first half of 2021, this situation will not change much, so large-scale fiscal stimulus will be unprecedented. Way to enter the commodity industry. The supply chain will Almost unbelievably slow Respond to this, “This will be truly prescient.

Another specious argument is that “CBO’s measure of potential output in 2021 is too high (although it has been adjusted downwards significantly due to the economic impact of COVID-19). Supply chain dysfunction and various factors that have led to partial shortages in the labor market In fact, the production capacity of the U.S. economy in 2021 is much lower than in 2019.” Again, this seems correct (although the decline in production capacity may be very short-lived), but it is not what they said.

The argument is Some ARP critics The closest thing to the real situation is that it might be better if the package plan spreads out the expenditure on fiscal relief and recovery measures more gradually over a longer period of time. I thought this was a strong argument at the time. However, in retrospect, since by September 2021, even if the ARP fiscal stimulus has basically subsided and the total output gap has not even narrowed, I think that the excessively rapid relief expenditure is not a major problem of causing inflation. The big problem again is that COVID-19 keeps spending on services at a low level and spending on goods at a high level, while putting the supply chain in trouble.

If I can go back to the past in an afterthought and fully control the policy making process around ARP, then the real way to better calibrate the package plan will be to ensure that commodity spending is gradually supported throughout the year, while spending services improve faster . However, there is no realistic way to do this. In theory, you can imagine a debit card for all Americans. It can only be used to purchase goods. The balance in the first month is $100, and then it gradually increases for several months, but there are bonuses. It is proportional to the balance carried over each month. This will incentivize consumers to postpone purchases as much as possible, but it will also signal to commodity producers that a wave of demand is coming-there is enough time to prepare to better prepare. But all of this is obviously very unrealistic in many different ways.

Two final thoughts on this ARP review:

First, as I mentioned above, the best argument against the ARP structure in real time is about the speed of spending. In fact, these are arguments against the stimulus checks contained in them-they are the main reason why ARP has been so advanced so far. As I said at the time, irritating inspections are not my favorite part of ARP, but a strange set of political constellations that make inspections almost impossible to rule out (the short story is that promise inspections are the key campaign plan January 2021 , The successful campaign of the Georgia Democratic Senate Candidate). Given the inevitability of the inclusion of checks, the disbursement argument is not sufficient to say no to the complete package.

Second, if we “better calibrate” ARP by reducing spending from January 2021 to September 2021, our inflation will indeed be lower today (goods spending will be lower, and service spending will be lower). But we will not create the 5.8 million jobs seen so far in 2021, wage growth will be slower, and personal income will be lower. Critics of ARP who point to current inflation want us to believe that a smaller ARP will only slow down inflation and not slow down the substantial economic improvement over the past nine months. They are wrong. Although I am dissatisfied with the inflation figures last month, I will not exchange them for 5.8 million jobs or higher personal income or faster wage growth.

Looking forward to the “Rebuild Better Act”

Although it is interesting to look back at ARP, it also has nothing to do with the policy question before us, namely, “Does the soaring inflation provide any important reason to cut the BBBA program that is being debated?” It definitely does not.even many critic (Or at least worry about) ARP support Investment required by BBBA.

In addition, unlike ARP, BBBA relies on tax financing instead of debt financing. For better or worse, this will weaken any inflationary impact it may have. In addition, the overall structure of BBBA expenditure is far less advanced than ARP. ARP aims to provide immediate financial relief and stimulus. BBBA aims to address the long-term investment shortage and safety net gap in the US economy. This means that in the long run, BBBA may increase the production capacity of the US economy and is expected to avoid the supply-side contraction that leads to soaring inflation as we have seen.However, in the following year, BBBA passed will not Affect inflation One way or another.

Finally, between the Fed’s announcement that it will slow down its bond purchases this month and the fact that fiscal policy will shrink significantly in 2022 (even if the BBBA is passed), there has been a substantial slowdown in general before us demand support. There is no reason to pile on it prematurely. Even if inflation figures have been too high in recent months, it is still true that overreactions to inflation events are usually more destructive than the events themselves. Policymakers should avoid this situation.

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