There are serious questions hanging over the American economy and the fall presidential election. So why are consumer prices still rising uncomfortably fast despite the Federal Reserve's sustained campaign to slow the economy by raising interest rates?
Economists and policy experts have offered several explanations. Some are inherently idiosyncratic to the current economic situation, such as rising home and auto insurance prices post-pandemic. Other long-term structural problems include a lack of affordable housing and rising rents in large cities like New York as prospective tenants compete for space. .
But some economists, including a senior official at the International Monetary Fund, said the federal government bears some of the blame because it continued to pump large amounts of borrowed money into the economy at a time when it didn't need fiscal stimulus.
This borrowing is the result of an increased federal budget deficit due to tax cuts and spending increases. It helps stimulate demand for goods and services by funneling money to businesses and people and getting that money to go out and spend.
IMF officials warned that the budget deficit was also leading to higher prices. They wrote in a report earlier this month that while recent U.S. economic performance has been impressive, it has been driven in part by a pace of borrowing that is “deviating from long-term fiscal sustainability.”
The IMF says U.S. fiscal policy has pushed up the country's inflation rate by about 0.5 percentage points, raising “near-term risks to the deflation process,” essentially suggesting the government is working at different objectives than the Fed. That's what I'm saying.
Biden administration economists and some Wall Street analysts reject that view. Administration officials said the analysis underlying the IMF's claims was impossible. Part of the reason is that at a time when direct consumer payments and other programs from President Biden's 2021 stimulus bill were increasing spending across the economy, federal policy is now at about the same level as it was two years ago. The report found that it was pushing up inflation.
Administration officials have cited other indicators of fiscal policy, including an ongoing analysis by the Brookings Institution in Washington that suggests the government's tax and spending policies are not currently or recently significantly boosting economic growth or inflation. It pointed out.
“I don't think the recent inflation record supports the excess demand narrative,” Jared Bernstein, chairman of the White House Council of Economic Advisers, said in an interview. “I think what we’ve seen is some cooling of demand in the job market as supply chain disruptions are resolved. Historically low unemployment rates despite significant inflation. We were able to maintain the
Bernstein said administration officials are careful not to comment on the central bank's interest rate decisions, but added: “Our fiscal stance is not fighting the Fed.”
The debate is important for how the Fed, which has primary responsibility for curbing price increases, sets policy in the coming months.
Investors entered the year expecting Fed officials to cut interest rates several times in 2023, as inflation slows rapidly and begins to approach the central bank's target level of 2% a year. They revised those forecasts as new data showed that progress was stalling and starting to reverse on many measures.
How policymakers view the interaction between budget deficits and inflation could also shape the decisions of the next president and Congress. If re-elected, Biden has said he would aim to reduce the deficit by about $3 trillion over 10 years, primarily by increasing taxes on high-income earners and corporations. His Republican opponent, former President Donald J. Trump, has reiterated his past and unfulfilled promise to bring the national debt to zero, while the budget deficit could rise by trillions of dollars in 2017. They also advocate extending the tax cuts.
The policies of both presidents and the decisions of their predecessors have contributed to the country's current fiscal imbalance. The deficit soared as Trump and then Biden signed relief bills for Americans and businesses during the coronavirus pandemic. It actually doubled last year, although it declined in fiscal year 2022.
The current budget deficit as a share of the economy is higher than historically normal at this point in the economic recovery, when unemployment is low and economic growth is strong.
That's true even when you exclude a measure economists call the “primary budget deficit,” the cost of repaying the government's growing debt burden, which soared last year as the Federal Reserve raised interest rates. Properly measured, last year's primary deficit was equivalent to about 5% of the economy's annual output. The primary deficit was the sixth highest since 1962, according to data from the nonpartisan Congressional Budget Office. The remaining five all occurred during or shortly after the pandemic or the 2008 financial crisis.
Large budget deficits can affect inflation in several ways. Demand for goods and services that are in relative short supply may increase, causing prices to rise. These could influence consumers' views on how much inflation they expect in the future and reduce the effectiveness of the Fed's rate hikes in response to slowing growth, said Joseph H. Davis, chief global economist at investment firm Vanguard. He said that there is a sex.
Davis said the shift from decreasing to increasing budget deficits is likely to push up price increases modestly, making the Fed's job more difficult. It's a headwind,” he said. .
Last year's increase in the deficit reflected several factors, including fluctuations in capital gains tax collections and the impact of natural disasters on tax returns. It also reflected increased government spending and tax cuts signed into law by Biden. The bipartisan 2021 infrastructure bill currently funds roads, broadband, and other projects across the country. The government pays additional health benefits to veterans exposed to toxic burns.
Tax incentives from bipartisan legislation aimed at boosting semiconductor production and partisan legislation aimed at accelerating the transition from fossil fuels to low-emission energy sources will save thousands of dollars on new factory construction. billions of dollars in announcements and spending were encouraged.
“It was a massive fiscal stimulus last year,” said Jason Furman, a Harvard economist who chaired the White House Council of Economic Advisers under President Barack Obama. He added: “We need to reduce the deficit to get people to lower mortgage rates and give businesses the ability to expand, invest and grow.”
Data from other economists, including the authors of Brookings' Hutchins Center Fiscal Impact Measures, suggests that spending increases and tax cuts last year did not outweigh the damage to the economy from expiring coronavirus relief measures. In other words, it effectively means that the end of the stimulus that supported consumer demand in the early stages of the pandemic has offset the increase in demand from new spending and tax cuts.
Economists at investment bank UBS wrote last week that after boosting growth last year, including by boosting factory construction, federal tax and spending policies are likely to “reverse” and drag growth this year. Economists at Bank of America Securities made a similar argument last week after the Commerce Department reported that economic growth had slowed in the first few months of the year.
Administration officials said there is a simpler and better explanation than the budget deficit for why inflation remains above the Fed's target. Housing inflation hasn't slowed as quickly as many economists expected, but White House models predict it will soon. Officials say the price increases for auto insurance, financial services and medical services are temporary in nature and will not continue to push prices higher in the coming months, although the current high level of inflation remains. .
“This isn't really about finances,” Bernstein said.
