Inflation: How much stimulus is too much?
When the pandemic passes, will there “be a huge burst of inflation?” asked Neil Irwin in The New York Times. The question is at the center of a heated debate among economists. Set off by a Washington Post column by former Treasury Secretary Larry Summers, policymakers have been arguing about whether the proposed $1.9 trillion “pandemic rescue plan is too big.” Inflation hawks believe the stimulus being poured into the pandemicdeflated economy exceeds what’s needed to bring it back to full potential. Instead of generating more real production, the extra money will “slosh around the economy, causing prices to rise” and creating the possibility of “a new recession.” The White House and Treasury Secretary Janet Yellen argue that the economy is in a “do-whateverit-takes moment” and that inflation is a “manageable risk.”
Think of what we’re getting now as a “war budget,” said Paul Krugman, also in the Times. It’s true that “wartime surges in spending have often been accompanied by bursts of inflation.” That’s not a reason for “skimping on Covid relief.” If indeed inflation does occur, “the Federal Reserve can tighten monetary policy”—as it has often been eager to do. The more immediate danger here is that the government spends too little to bring the economy back to capacity and we lose the political wherewithal for additional spending. That’s what happened in 2009. If we don’t do enough now, Mitch McConnell will come back just as he did then, saying, “See, government spending doesn’t work.” Summers is a “natural gadfly” who’s actually been arguing for years that the U.S. needs to combat stagnant growth with increased federal spending, said Jordan Weissmann in Slate .com. “Now that Washington’s purse is open, he’s suddenly freaking out.”
There are several genuine reasons for alarm, said Bill Dudley in Bloomberg.com. The pandemic has “wiped out a lot of small businesses,” meaning there “won’t be enough capacity to meet resurgent demand” as the economy reopens. And many households have money to spend that they saved over the months of lock-ins. That’s a recipe for higher prices. If the Fed has to “pull back on stimulus sooner and with greater force than anticipated,” there may be a “volatile market reaction.”
For the moment, markets aren’t worried, said James Mackintosh in The Wall Street Journal. Investors seem to be pricing in “the sort of inflation they like, slightly higher in the next few years but moderating back down after that.” The situation we saw in the 1970s came about “in large part because powerful unions were able to demand wages rise with prices, pushing companies to raise prices, in a nasty spiral.” The labor market is quite different now. There’s also more “faith in the Fed” to forestall any disaster. “I very much hope such faith isn’t misplaced.”