The combination of the $1.9 trillion COVID relief package and the lifting of more coronavirus restrictions is set to deliver a jolt to the already fast-growing US economy, potentially summoning the return of a long-absent economic phenomenon: inflation.
Not the sky-high inflation of the 1970s and ’80s, which led to federal wage and price controls, double-digit mortgage rates, and a presidential initiative that featured campaign-style buttons imploring Americans to “Whip Inflation Now.” Economists agree those days are not coming back anytime soon, if ever.
In fact, the problem in recent decades has been that inflation — the general rise in prices for everything over time ― has been stubbornly low. That’s almost certainly about to change as the nation emerges from the pandemic with pent-up demand and money to spend, as most Americans soon will receive $1,400 direct payments from the relief bill, along with additional aid.
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But economists said an increase in inflation isn’t necessarily a bad thing. Moderate inflation is actually good for the economy, leading to increased pay for workers among other benefits — as long as it doesn’t spiral out of control.
“We’ve had undesirably low inflation for 25 years. I say bring on the inflation, please,” said Mark Zandi, chief economist at Moody’s Analytics, an economics research and consulting firm. “There might be some immediate sense of, ‘What’s this? I haven’t seen this before.’ But I think we’ll get used to it pretty fast if employers say now you’re going to get a 3 percent wage increase.”
The challenge falls to Federal Reserve policymakers to prevent too much inflation, which would offset those bigger paychecks with larger shopping bills and the higher interest rates that could come with a fast-growing economy. Critics of President Biden’s coronavirus bill said its massive size, coming on top of about $4.1 trillion in relief spending authorized by Congress last year, makes that job more difficult by threatening to greatly accelerate inflation.
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Those concerns aren’t just coming from congressional Republicans, who were united in opposition to the latest bill, called the American Rescue Plan. Larry Summers, who was a top economic adviser to former president Barack Obama, fanned the inflation fears when he warned in an opinion column last month that “there is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation.”
Those fears have been amplified by a policy shift announced by the Fed last fall that is designed to avoid the problem that occurred after the Great Recession, when worries that the annual inflation rate was approaching the central bank’s 2 percent target led officials to start increasing interest rates before the job market had fully recovered. The Fed was sharply criticized for the hikes by progressive activists because unemployment rates were much higher for people of color and in marginalized communities.
“For decades, the Fed has seen the economy through the eyes of the financial sector and Wall Street bankers and has overemphasized keeping prices stable to the detriment of genuinely getting to maximum employment,” said Benjamin Dulchin, director of Fed Up, a grass-roots coalition of labor, community, and liberal activist groups that protested rate hikes that began in 2015 and plans to pressure the Fed to keep rates low now for longer. “To put it bluntly, a high unemployment rate is racist, an attack on working people, and, in many ways, a Fed policy choice.”
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Fed Chairman Jerome Powell has said that after the experience with the slow recovery from the Great Recession, the Fed is prepared to let inflation run higher for a while before trying to push it down by increasing interest rates.
“Our new framework says that we will seek inflation that runs moderately above 2 percent for some time after we’ve had a shortfall of inflation,” Powell said at a Wall Street Journal forum this month. “It commits us to not raise interest rates just because the labor market gets strong.”
Inflation could be allowed to run above 2 percent for a while because the labor market has a long way to go before it recovers its past strength. The US economy still has 9.5 million fewer jobs than it did when the pandemic hit a year ago and about 20 million Americans are receiving unemployment benefits.
Biden and congressional Democrats have argued that the pandemic’s severe economic damage means there’s greater risk in doing too little right now to address it than too much. That calculation is partly based on the difficulty of pushing large-scale spending bills through Congress with the Democrats’ slim majorities if the economy needs more help, compared to the quick action that Fed officials can take to stem an overheating economy by raising interest rates from their current near-zero level.
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“One of the lessons of 2009 and the recovery efforts coming out of the Great Recession is it is hard to move at the scale and speed necessary to have fiscal policy respond if you’ve done too little,” said Brian Deese, director of the White House’s National Economic Council. When it comes to the potential for the bill to cause high inflation, he said, “We’re attentive to all manner of economic risks, so we don’t take anything for granted.”
Inflation already is rising after a $900 billion COVID relief package enacted in December that included direct $400 payments for most Americans. The consumer price index, a key inflation measure, was up 1.7 percent for the 12 months through February, the highest level in a year, although it remains below the Fed’s target and longer-term measures of inflation expectations remain in check.
But the scope of the economic damage from the pandemic is so severe that it requires revised thinking about inflation during this recovery, said Diane Swonk, chief economist at the accounting and advisory firm Grant Thornton.
“The problem is a meteor hit the Earth and knocked it off its axis and people keep trying to apply the old rules of gravity, but they don’t apply,” she said. “There will be inflation. But will it be something the Fed should raise rates over? I would be awfully careful about that.”
Economists said the inflation jump we’re likely to see in the coming months should be short-lived and could appear worse than it actually is.
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When the pandemic took hold last March and the nation went into lockdown, the economy cratered and prices plunged. The consumer price index declined for three straight months. So year over year, inflation this spring is going to look artificially high by comparison. On top of that, the combination of increased vaccinations and fewer coronavirus restrictions is likely to lead to a surge in demand for some things, like airline tickets, and short supply could lead to temporary price spikes.
“There may be more passengers chasing not enough seats. In that case, fares will go up until that capacity and demand sync up,” said Greg McBride, chief financial analyst at Bankrate.com, a financial information website. “People want to do things and industries scaled back because they weren’t doing them. ... Not every hairdresser or nail tech that was in business in February 2020 is still in business now.”
But it’s a long way from those types of price spikes, caused by short-term mismatches in supply and demand, to sustained high inflation. In order to get that, economists said, wages would have to increase in tandem with prices. That’s what happened in the 1970s, when automatic cost-of-living allowances were common for workers, baking sharp increases in oil prices into the overall economy and helping send annual inflation into double digits.
The Fed finally succeeded in taming what’s known as “The Great Inflation” by increasing interest rates into double digits from the late 1970s through the mid-1980s to reduce demand. That triggered two recessions and pushed 30-year fixed-rate mortgages to a high of nearly 19 percent at one point.
Douglas Holtz-Eakin, a former director of the Congressional Budget Office, said he’s not concerned the coronavirus relief spending will cause anywhere near that kind of inflation problem. He’s more worried that the $1.9 trillion bill is much larger than needed right now. The Organization for Economic Cooperation and Development, a group of the world’s 37 most advanced economies, on Tuesday doubled its estimate for US growth this year to 6.5 percent because of the stimulus coming from the relief bill and the faster pace of vaccinations. That growth rate would be the strongest since the mid-1980s.
Injecting so much money into a fast-growing economy could lead to dangerous bubbles in housing prices and the stock market as many people search for ways to spend it, said Holtz-Eakin, president of the conservative-leaning American Action Forum think tank.
“We’re going to send $400 billion in checks out and a lot of that is going to go to people who haven’t lost a day of work or a dime of salary, and my nightmare scenario is they all just got the Robinhood app,” he said. “There’s a lot of money sloshing around out there.”
Jim Puzzanghera can be reached at jim.puzzanghera@globe.com. Follow him on Twitter: @JimPuzzanghera.