Does Aggressive U.S. Pandemic Relief Risk an Unacceptably Big Future Inflation Problem?

March 29, 2021

Economists are divided on this question. Although more feel any inflationary fallout will be either temporary or manageable, some big names in the field like former Treasury Secretary Summers believe that the combination of prolonged very stimulative monetary policy, the CARES Act, subsequent government relief packages, and the Biden Administration’s fiscal plans to rebuild infrastructure and address other imbalances will producer an inflationary overkill.

For several reasons, I come down on the side that thinks the risks of doing too little outweigh the inflationary risks of government doing too much. Number one, the U.S. economy has experienced two substantial recessions in succession that leave productive resources highly underutilized. The Great Recession of 2008-09 was the biggest downturn since the 1930s depression, and the 2020-21 pandemic created an even more omnipresent shock to the system. The intervening business upswing was long but subpar in strength. Fiscal support in 2009 was too timid, and worrisome structural trends like increasingly uneven distributions of wealth and income didn’t begin to reverse until very late in the recovery. Measures of economic slack are subject to interpretation, but a telling indication that such remains enormous is this. If one extrapolates the growth of U.S. jobs from 1980 through the end of 1999 forward to the present, the actual current level of nonfarm payroll employment is almost 50 million workers below that¬† trendline.

Number two, it proved hard to cleanse the economy of excessive inflation that reached its zenith in 1980. But it’s now equally apparent that once inflation becomes very low, it is also very hard from a policy perspective to increase inflation on a sustainable basis. Fed officials target inflation at 2.0% but have delivered sub-target results for much of the 21st century. Not only has the path of inflation undershot the target with great frequency, but it has consistently underachieved the expectation of officials.

The third argument is related to the second and involves the nature of what is meant by price equilibrium. Regarding the price of a single good or service, equilibrium while all forces impacting supply and demand for that product remain unchanged is characterized as a specific price at which the market exactly clears. Product supply at that price level is the same as what buyers want to buy at that price. But for inflation, which concerns the average movement of all goods and services prices, one tends to observe price equilibrium as a trend rather than a point. Undesirably high inflation creates expectations of rising prices, and the reverse is also true.

Number four, among baby boomer and genx economists, a breakdown in price stability tended to be framed in terms of excessive and accelerating inflation. That’s understandable because it describes the experience they observed in their formative studies. From the vantage point of 2021 and looking back over a lifetime, one sees that high inflation was the aberration and not the rule. For 18 years through 1965, U.S. CPI inflation averaged about 1.o%. An upward trend began midway through the 1960’s but did not hit its peak until fifteen years later. The average rise of consumer prices over the quarter century through 1992 was just slightly under 6.0% but was well below that mean much of the time after Fed restraints on money growth broke inflation’s back in the early 1980s. Likewise, inflation has averaged 2.2% since 1992 but just 1.6% over the latest eight years.

Number five, central banks have the wherewithal to reverse inflation that’s become too high and is threatening to accelerate additionally. That doesn’t insure that such will be done because political will might be lacking. Reversing deflation or even raising inflation that has become too close to zero percent is far less assured. Just look at Japan’s experience. Consumer prices climbed around 5.3% a year in the second half of the 1960s and then 9.1% per year in the decade through 1980 including 23.2% in 1974. Inflation slowed to 2.1% in the 1980s but stalled altogether in the ensuing decade when the Bank of Japan overplayed its hand.¬† Over the last three successive decades, CPI inflation in Japan averaged 0.8% per year, then -0.3% a year and most recently 0.5% per year.

Number six, the consequences for economic growth are more severe when inflation gets too low than too high. Remember that quarter-century when U.S. inflation averaged almost 6% a year? It included both OPEC price shocks and deep recessions in 1973-5 and 1980-82, yet real GDP over the entire period advanced at a mean rate of 3.2% per year. Japanese growth had been so robust in the 1960s, 1970s, and 1980s that recessions for that period were redefined to be any period of a couple of quarters in which growth dropped below 3.0%, not zero percent as most countries differentiate expansion from contraction. But since the onset of low or negative movement in prices some 30 years ago, Japan’s economy has struggled through many recessions and other periods of sub-2% growth.

Number seven, inflation has strong global properties. Countries tend to experience high or low inflation together. In June 1980 when U.S. inflation was near peak at 14.5%, CPI inflation had also climbed to 84.3% in Brazil, 21.0% in the U.K., 20.7% in Italy, 20.4% in the Philippines, 20.2% in Ireland, 17.9% in New Zealand, 15.6% in Spain, 10.1% in Canada, 11.5% in Hong Kong, 13.2% in France, 8.4% in Japan, and 6.0% in Germany. Inflation is now at 1.7% in the U.S. and in those other economies at 5.2% in Brazil, 0.4% in U.K., 0.6% in Italy, 4.7% in the Philippines, -0.4% in Ireland, 1.4% in New Zealand, 0.0% in Spain, 1.1% in Canada, 0.4% in Hong Kong, 0.6% in France, -0.4% in Japan, and 1.3% in Germany. To argue that U.S. macroeconomic policy proposals now risk revisiting America’s inflationary landscape of a half century ago is likely to presume that inflation also climbs extensively throughout the world.

Moreover, the journey to high enough inflation to unhinge low inflation expectations and put America at risk of going back to the 1970s and 1980s would be a long drawn-out process, and having lived that scenario once before, it’s highly unlikely that the Federal Reserve would repeatedly dismiss the warning signs. They have the tools to stop the process long before inflation becomes a problem that’s terribly costly to eradicate.

On the other hand, by erring on the side of achieving less inflation than desired, the United States has settled for an extended period of deficient economic growth and increasingly uneven economic progress. There is a connection between that economic bargain and the erosion of U.S. political cohesion to its greatest extent in a century and a half. All things considered, the risks of deficient policy support seem to far exceed the risks of too much stimulus over the next year or two.

Copyright 2021, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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