A crucial question hangs over the American economy and this fall’s presidential election: Why are consumer prices still rising uncomfortably quickly, even after a sustained campaign by the Federal Reserve to slow the economy by raising interest rates?
Economists and policy experts have offered several explanations. Some are essentially idiosyncrasies of the current economic situation, such as a delayed increase in the cost of home and vehicle insurance following the pandemic. Others are long-term structural problems, such as the lack of affordable housing that has driven up rents in major cities like New York as potential tenants compete for apartments.
But some economists, including top officials at the International Monetary Fund, said the federal government bore some of the blame because it continued to pump large amounts of borrowed money into the economy at a time when the economy did not need fiscal stimulus.
This borrowing is the result of a federal budget deficit that has been increased by tax cuts and spending increases. It helps stimulate demand for goods and services by funneling money to businesses and people who then spend it.
IMF officials warned that the deficit was also driving up prices. In a report earlier this month, they wrote that while America’s recent economic performance has been impressive, it is being driven in part by a pace of borrowing “that is not consistent with the long-term sustainability of public finances.”
The IMF said U.S. fiscal policy increased the national inflation rate by about half a percentage point and increased “near-term risks to the disinflation process” – essentially saying the government was working at odds with the Fed.
Biden administration economists and some Wall Street analysts reject that view. Government officials said the analysis underlying the IMF’s claims was implausible. That’s in part because the report found that federal policy is currently contributing to inflation as much as it did two years ago, at a time when direct payments to consumers and other programs from President Biden’s 2021 stimulus plan increased spending across the economy.
Administration officials pointed to other fiscal policy measures, including an ongoing analysis by the Brookings Institution in Washington that suggested the government’s tax and spending policies have not contributed significantly to economic growth or inflation, either now or in the recent past.
“I don’t think the recent inflation record supports the excess demand story,” Jared Bernstein, chairman of the White House Council of Economic Advisers, said in an interview. “I think what we’ve seen is that demand in the labor market has cooled a bit as supply chains have eased. We were able to maintain historically low unemployment while significantly reducing inflation.”
Mr. Bernstein added that while government officials were careful not to comment on the central bank’s interest rate decisions, “our fiscal stance is not anti-Fed.”
The debate is important for how the Fed, which has primary responsibility for controlling price growth, sets policy in the coming months.
Investors earlier this year expected Fed officials to cut interest rates several times after price growth slowed rapidly in 2023 and began to approach the central bank’s target level of 2 percent per year. They have revised those forecasts as new data shows progress is stalling and, in many ways, beginning to reverse.
How policymakers view the interaction between deficits and inflation could also influence the decisions of the next president and Congress. Mr. Biden said that if re-elected, he would seek to cut deficits by about $3 trillion over a decade, mostly through tax increases on high earners and corporations. His Republican opponent, former President Donald J. Trump, has reiterated his previous – and unfulfilled – promises to eliminate the national debt while pushing for an extension of his 2017 tax cuts that could add trillions to the deficit.
The policies of both presidents, as well as the decisions of the presidents before them, have contributed to the country’s current fiscal imbalance. The deficit rose as Mr. Trump and then Mr. Biden signed relief bills for people and businesses amid the coronavirus pandemic. It fell in fiscal year 2022, but effectively doubled last year.
The deficit, as a percentage of economic output, is now larger than has historically been typical for this point in an economic recovery – when unemployment is low and economic growth remains strong.
That’s true even if you exclude the costs of servicing the government’s ballooning debt load, which soared last year when the Fed raised interest rates, a measure economists call the “primary deficit.” If measured correctly, the primary deficit last year was equivalent to about 5 percent of the economy’s annual output. Data from the nonpartisan Congressional Budget Office suggests it was the sixth-highest primary deficit of any year since 1962; The other five all occurred during or immediately after the pandemic or the 2008 financial crisis.
Large deficits could affect inflation in a number of ways. They could increase demand for goods or services that remain relatively scarce, thereby driving up prices. They could influence consumers’ views about how much inflation they expect in the future and reduce the effectiveness of Fed rate hikes in slowing growth, said Joseph H. Davis, chief global economist at investment firm Vanguard.
Mr. Davis said the shift from falling to rising deficits was most likely contributing slightly to price growth and making the Fed’s job more difficult: “What used to be a tailwind for inflation has become more of a headwind,” he said.
Last year’s deficit increase reflected several factors, including fluctuating capital gains tax revenues and the impact of natural disasters on tax returns. This also reflected increased government spending and tax breaks that Mr. Biden signed into law. A bipartisan 2021 infrastructure bill now funds roads, broadband and other projects across the country. The government pays additional health benefits for veterans exposed to toxic burn pits.
Tax incentives in a bipartisan bill aimed at boosting semiconductor production and a bipartisan bill aimed at accelerating the transition from fossil fuels to lower-emission energy sources have sparked hundreds of billions of dollars in announcements or spending to build new factories.
“It was a big dose of fiscal stimulus last year,” said Jason Furman, a Harvard economist and chairman of the White House Council of Economic Advisers under President Barack Obama. “To give people lower mortgage rates,” he added, “to give businesses the opportunity to expand, invest and grow, we must reduce the deficit.”
Data from other economists, such as the creators of the Hutchins Center Fiscal Impact Measure in Brookings, suggests that last year’s spending increase and tax relief did not outweigh the drag on the economy from expiring Covid relief. In other words, they effectively show that the end of the stimulus that supported consumer demand in the early stages of the pandemic offset increased demand with new spending and tax relief.
Economists at investment bank UBS wrote last week that federal tax and spending policies, after boosting growth last year, including by encouraging factory construction, were likely to become a drag on growth this year. Economists at Bank of America Securities made similar comments last week after the Commerce Department reported that economic growth slowed in the early months of this year.
Administration officials said there were simpler — and better — explanations for why price growth remained above the Fed’s target than for the deficit. Housing inflation has not eased as quickly as many economists had expected, although White House models expect it to do so soon. The rise in prices for auto insurance, financial services and medical services is effectively a one-time effect that is keeping inflation high now, officials said, but will not push prices higher in the coming months.
“It’s not really a fiscal story,” Mr. Bernstein said.
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2024-04-29 16:50:56
www.nytimes.com
