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President Joe Biden’s $1.9 trillion coronavirus relief package is speeding toward passage — maybe before mid-March.
But as Congress prepares the massive rescue package, a few prominent left-wing economists have been sounding the alarm on inflation risk, conjuring up images of the 1970s, when the central bank struggled to control rising prices that wiped out wage gains.
The most notable voice warning of inflation risk came from inside the Democratic Party. Lawrence Summers, former treasury secretary for Bill Clinton and economic adviser to Barack Obama, wrote in an op-ed for The Washington Post that Biden’s stimulus might cause “inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability.”
Olivier Blanchard, former chief economist at the IMF, agreed with Summers on Twitter, writing that the package could “overheat the economy so badly as to be counterproductive.” A few weeks later, Blanchard defended his concerns in an article for the Petersen Institute, a nonpartisan think tank.
“I think in general forecasts of how hot the economy will be have moved up, such as the Atlanta Fed forecast, which I suspect is an exaggeration, but they held out the prospect of 9% growth in the first quarter. And certainly there’s been a fairly significant upwards move in rates,” Summers told Insider of changes he’s seen since he’s published his op-ed.
Even the government’s own budgetkeeper, the Congressional Budget Office, currently sees real GDP exceeding projected output by a wide margin even without the stimulus, according to an economic outlook report published earlier this month. That means Biden could be pumping more money into the economy than he needs to.
To understand what they’re really worried about, you have to understand what was happening with inflation in the 1970s and ’80s, the period that haunts the memories of economists of Summers’ generation. (Only the oldest millennials have even a faint recollection of a period with high inflation.)
Inflation peaked in 1975 at 10.1%, before falling the following year to 5.9%. But in a sign of how difficult it was to manage, it was back up to 9.6% by 1981.
Inflation isn’t just something from economics textbooks: it could be the difference between mortgages having an interest rate around 3%, the average since 2020, or north of 10%, the average at one point during the dreaded 1970s. Or, in the case of so-called hyperinflation, it could be the difference between the price of a loaf of bread increasing by a few cents per month or doubling every 25 hours, as it did in Zimbabwe just in 2008.
America’s central bank, the Federal Reserve, developed a lot of tools to fight that kind of inflation, so it’s worth looking at how it did that, and what’s different now.
A brief history of how the Fed (used to) fight inflation
From around midcentury through the 1970s, the Federal Reserve had sought to solve this problem by pushing for less deficit spending and increasing interest rates as unemployment fell. But that prompted employers to overpay their workers while raising prices on consumers to cover the pay hikes. Consumers in turn demanded even more pay from their employers, and inflation proved tough to tame.
By the early 1980s, though, the Fed had a new chair: Paul Volcker, appointed by Democratic President Jimmy Carter.
Volcker inherited a certain philosophy, in which the central bank would raise interest rates to try to keep inflation under control. But Volcker reversed the Fed’s previous policies, focusing on money supply instead of interest rates, and interest rates plummeted throughout the rest of the decade, where they’ve stayed since.
In fact, the Federal Reserve’s benchmark interest rate has been near zero for most of the years since 2008 — and there’s no indication that will change anytime soon. As of December 2020, the inflation rate was hovering around 1.5%.
Summers pointed out to Insider that zero interest rates were once “dismissed” as unrealistic and yet now they are in place, “and I think people who dismiss the possibility of significant increases in inflation today are making a similar error.”
Wall Street increasingly sees little inflation risk
It’s likely the US isn’t going to see a repeat of the 1980s because today’s economy is different.
While pandemic savings, a strong stimulus, and the beginning of vaccinations caused a “pop in prices,” globalization and technology help keep prices at bay, Tom Barkin, president of the Richmond Fed, told the Financial Times. Inflation could occur if these trends undergo a long-term shift or if businesses are unable to increase supply to meet demand, he said, while deeming both of these outcomes unlikely.
Barkin said that he expects “short-term price volatility” and sees both deflationary and inflationary risks. “I’m keeping my focus on medium-term [inflation] expectations,” he added.
Also, while much of Wall Street initially forecasted inflation risk in the first weeks of Biden’s presidency, banks increasingly have a more optimistic outlook.
In a note released on Thursday, UBS economists led by Alan Detmeister stated that the stimulus probably wouldn’t cause a surge in inflation, with any inflation effects “likely to be small.” On Wednesday, Goldman Sachs economists led by Jan Hatzius also signaled a low possibility of inflation, estimating the US output gap is more than twice the size projected by the CBO, meaning that the hole in the economy that Biden is trying to fill is actually pretty close to $1.9 trillion.
Inflation for consumer goods thus far in 2021 has been lower than analysts’ expectations, as they predicted a median 0.2% increase month-over-month and 1.5% year-over-year. But the core annual inflation rate actually dropped from 1.6% in December to 1.4% in January.
US banking officials think they have the right tools to fight inflation
The US has also developed better tools to handle inflation than it had in the 1980s, which Treasury Secretary Janet Yellen referred to when she recently dismissed inflation concerns.
“I’ve spent many years studying inflation and worrying about inflation. And I can tell you we have the tools to deal with that risk if it materializes,” she told CNN in January. “But we face a huge economic challenge here and tremendous suffering in the country. We’ve got to address that. That’s the biggest risk.”
On a CNBC appearance later in February, Yellen said inflation has been “very low for over a decade, and you know it’s a risk, but it’s a risk that the Federal Reserve and others have tools to address.”
Yellen’s comments echo those of the current Fed chair, Jerome Powell, who sees a huge difference between now and the aforementioned 1970s. “Inflation has been much lower and more stable over the past three decades than in earlier times,” Powell said this week in a speech to the Economic Club of New York. “In the 1970s, when inflation would go up, it would stay up,” he said.
“The experience with the Fed and the experience with controlling excessive inflation, is that the vast majority of the time it leads to recession. And so I don’t really understand the basis for serenity,” Summers said. “I think it would be helpful to spell out the basis for believing that when the Fed is not concerned with inflation, that if inflation accelerates, it will be dealt with in a way that is not disruptive to output and financial markets.”
Anna Stansbury is a PhD Scholar at Harvard University’s program in inequality and social policy who has co-authored research with Summers.
She told Insider that while she doesn’t think it’s unreasonable to worry about inflation in regards to the package, the cost of it would be relatively low — and that “we have policy tools that we know how to use to control inflation.”
“I think it’s worth sending some income to the people who don’t need it in order to make sure that we try and get income to the people who do,” she said. “In a situation where a strikingly large number of families are reporting that they’ve actually not had enough to eat — when the situation is so dire — I think it’s worth taking that risk.”
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