Are higher prices temporary or signs of looming inflation. Two economists with Democratic credentials disagree. Treasury Secretary Janet Yellen said higher prices reflect short-term supply chain shortages. Larry Summers, a former top economic adviser to Presidents Barack Obama and Bill Clinton, warns the US economy is overheating because of too much short-term federal stimulus.
Inflationary fears were stoked by a government report indicating consumer prices rose 4.2 percent in April compared with April 2020 as economic lockdowns took hold in response to the COVID-19 pandemic. Prices on a seasonally adjusted basis rose 0.8 percent from March to April this year. A less-than-predicted jobs report in April added to the worries.
“Policymakers at the Fed and in the White House need to recognize that the risk of a Vietnam inflation scenario is greater than the deflation risks on which they were originally focused,” says Summers, who is quick to add he favors Biden’s ideas for longer-term stimulus. “Wherever possible, [the Biden administration] should try to defer spending rather get it out the door as soon as possible,” he says
Speaking at a Wall Street Journal CEO Council event, Yellen dismissed the threat of inflation, noting prices have risen because demand in a reopening economy is outstripping supply, which was cut back during the pandemic. Once supply has caught up with demand, upward pressure on prices will abate. “Is there a risk of inflation? I think there’s a small risk. And I think it’s manageable.” Interest rates, she adds, may gently rise gently over the next couple of years. Fed Chair Jerome Powell has said there are no immediate plans to rachet up interest rates.
“The most significant risk we face is a workforce that is scarred by a long period of unemployment,” Yellen contends. “People being out of work, not able to find jobs, can have a permanent effect on their well-being. I think that’s the most significant risk,”
Public concern over inflation rose when ransomware hackers invaded Colonial Pipeline’s computer system, forcing it shut down its systems that supply gasoline to the Southeast section of the country. Media coverage zeroed in on long lines at gas stations, hooded gas pumps and panic gas purchases.
The US stock market reflected concern, less about price increases and more about the prospect of Fed hikes to interest rates to quell inflation. Congressional Republicans saw the prospect of inflation as another argument against the $4 trillion initiatives President Biden has proposed to boost jobs and plug holes in the social safety net.
Underlying the debate over a return to inflation is the Biden administration’s concern that an underwhelming stimulus will lead to a languid economic recovery, the lesson Democrats say they learned by tempering their response to the 2008 recession. Biden spokespersons continue to urge a “Go Big” strategy and not be deterred by a single month’s statistics. Biden’s Press Secretary Jean Psaki noted prices for airline tickets and hotel rooms have risen, but they remain lower than before the pandemic.
Economists also say economic recovery was stunted by too much concern over the threat of inflation, which took the form of interest rate increases. The Fed was trying to keep unemployment low while keeping inflation in check. Since then, economists have concluded unemployment can fall even more without triggering inflation.
No one really knows how the current economy will respond as it begins to reopen from lockdowns and workarounds in response to a once-in-a-century pandemic. As one Biden official put it, “We need to be cautious and humble. We haven’t been through this before. The path to getting between here and normal to going to be bumpy and uncertain.”
In an interview with Business Insider, economist Paul Krugman says, “Anyone who wasn’t expecting to see some prices of some things rise as the economy came roaring out of the pandemic wasn’t paying attention. I’m going to be tracking this like everyone else. In the past, just the Fed’s core inflation was good enough. I don’t think that that will work this time, because we’re going to have special bottlenecks that will affect core prices as well.”
Krugman predicts the US economy could grow by as much as 8 percent this year. “I think we’re likely to have an economy that’s looking hotter than is sustainable by early next year,” he says. “Not in a scary sense, but nonetheless overheated by early next year. But we’ll also be looking at a looming fiscal contraction because the American Rescue Plan will have done its thing already.”
“We’ve learned two lessons from the past dozen years. The US economy can in fact run a lot hotter than we thought. It is, in fact, okay to have nice things. We can have full employment and it doesn’t mean that that hyperinflation is around the corner. And the debt doesn’t seem to be a problem at anything near current levels,” Krugman explains. “There’s basically not much of a downside to having a very rapid economic recovery. If you’re an ordinary American, you can say, look, the odds are that by this time next year, jobs will be plentiful, things will be looking pretty good. Inflation might be a bit higher, but your income will be more than keeping up with it.”
Inflation itself has become a more welcome economic guest. The Fed’s target inflation rate is 2 percent annually, not zero. The average inflation rate a few decades ago was 6 percent and occasionally burst into double digits. Modest inflation can make repaying debts a little easier and provide a rationale for higher wages and higher prices. It also can give the Fed reason to inch up interest rates – and later the room to lower them if the economy stagnates or heads downward.
We’ve learned two lessons from the past dozen years. The US economy can in fact run a lot hotter than we thought. We can have full employment and it doesn’t mean that that hyperinflation is around the corner.
Alongside the introspection of inflation is a related debate over fiscal stimulus and national debt. Republicans built their conservative bona fides on restricting government spending to prevent the growth of national debt. With their embrace of supply-side economics and tax cuts for corporations and the wealthy, those bona fides have been tested as those policies failed to fuel the economic growth necessary to net out the loss in tax revenue.
President Biden’s fiscal policies harken back to FDR’s New Deal, which were designed to pull the nation out of an economic depression. Biden believes the national economy has been disrupted by the global pandemic, which exposed gaping holes in the social safety net as well as underscored aging infrastructure that can restrict economic growth. He is gambling that huge expenditures now can pay dividends later in a broader based, more sustained economic recovery. And, after $4 trillion spent on pandemic financial relief, Biden wants to pay for his jobs, infrastructure and family support plans by restoring higher tax rates on corporations and wealthy individuals.