A crucial question looms over the U.S. economy and the fall presidential election: Why do consumer prices continue to grow uncomfortably fast, 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 quirks of the current economic moment, such as a delayed, post-pandemic increase in the cost of home and auto insurance. Others are long-standing structural problems, such as the lack of affordable housing that has driven up rents in big cities like New York as prospective tenants compete for units.
But some economists, including senior officials at the International Monetary Fund, said the federal government was partly to blame because it had continued to pump large amounts of borrowed money into the economy at a time when the economy did not need a fiscal boost.
That debt is the result of a federal budget deficit that has been inflated by tax cuts and spending increases. It’s helping to drive demand for goods and services by funneling money to businesses and people who then go out and spend it.
IMF officials warned that the deficit was also driving up prices. In a report earlier this month, they wrote that while the recent U.S. economic performance was impressive, it was driven in part by a pace of borrowing “that is not in line with long-term fiscal sustainability.”
The IMF said U.S. fiscal policies were adding about half a percentage point to the national inflation rate and raising “near-term risks to the disinflation process,” essentially saying the government was working at cross-purposes. Federal Reserve.
Biden administration economists and some Wall Street analysts reject that view. Administration officials said the analysis underlying the IMF’s claims was implausible. That’s in part because the report found that federal policy was adding as much to inflation today as it did two years ago, at a time when direct payments to consumers and other programs in the president’s 2021 stimulus bill Biden were increasing spending across the economy.
Administration officials pointed to other fiscal policy measures, including an ongoing analysis by the Brookings Institution in Washington, which suggested the government’s tax and spending policies were not contributing significantly to economic growth or inflation now or in the recent past. .
“I don’t think the recent record high inflation supports a story of excessive demand,” Jared Bernstein, chairman of the White House Council of Economic Advisers, said in an interview. “I think what we’ve seen is that as supply chains have unraveled, demand in the labor market has cooled a little bit. “We have been able to maintain historically low unemployment while achieving significant disinflation.”
Bernstein added that while administration officials were careful not to comment on the central bank’s interest rate decisions, “our fiscal stance is not fighting the Fed.”
The debate is important over how the Federal Reserve, which has primary responsibility for controlling price growth, sets its policy in the coming months.
Investors began the year expecting 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 annually. They have revised those forecasts as new data shows progress is stalling and, by many indicators, beginning to reverse.
How policymakers view the interplay between deficits and inflation could also influence the decisions of the next president and Congress. If he is re-elected, Biden said he would seek to reduce deficits by about $3 trillion over a decade, primarily by raising taxes on high-income earners and corporations. His Republican opponent, former President Donald J. Trump, has repeated his past – 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, along with the decisions of presidents before them, have contributed to the country’s current fiscal imbalance. The deficit soared as Trump, and then Biden, signed aid bills for individuals and businesses amid the coronavirus pandemic. It fell in fiscal 2022, but effectively doubled last year.
The deficit is now higher, as a percentage of the economy, than is historically normal at this time of an economic recovery, when unemployment is low and economic growth remains strong.
This is true even if you exclude the costs of servicing the government’s growing debt load, which soared last year when the Federal Reserve raised interest rates, a measure economists call the “primary deficit.” When properly measured, last year’s primary deficit 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 occurred during or immediately after the pandemic or the 2008 financial crisis.
High deficits could affect inflation in several ways. They could increase demand for goods or services that remain relatively scarce, driving up prices. They could affect consumers’ views about how much inflation they expect in the future and undermine the effectiveness of the Federal Reserve’s rate increases in slowing growth, said Joseph H. Davis, global chief economist at the investment firm Vanguard.
Davis said the move from a declining to a growing deficit was probably contributing modestly to price growth and making the Fed’s job more difficult: “What used to be a tailwind for inflation has become a tailwind. against,” he said.
The rise in the deficit last year reflected several factors, including volatile capital gains tax collections and the effects of natural disasters on tax filing. It also reflected increased government spending and tax breaks enacted by Biden. A bipartisan 2021 infrastructure bill now funds roads, broadband and other projects across the country. The government is paying additional health benefits for veterans exposed to toxic burns.
Tax incentives in a bipartisan law aimed at boosting semiconductor production and a partisan law aimed at accelerating the transition from fossil fuels to lower-emission energy sources have spurred hundreds of billions of dollars in announcements or construction spending. of new factories.
“It was a big dose of fiscal stimulus over the last year,” said Jason Furman, a Harvard economist who chaired the White House Council of Economic Advisers under President Barack Obama. “To get people to lower their mortgage rates,” he added, “to give businesses the ability 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 at Brookings, suggest that increased spending and tax breaks last year did not offset the drag on the economy from the expiration of Covid relief. In other words, they effectively show that the end of the stimulus aid that boosted consumer demand in the early stages of the pandemic offset any increase in demand coming from new spending and tax breaks.
Economists at investment bank UBS wrote last week that after boosting growth last year, including by boosting factory construction, federal tax-and-spend policy is likely to “become” a drag on growth this year. Economists at Bank of America Securities made a similar argument last week after the Commerce Department reported that economic growth slowed in the first months of this year.
Administration officials said there were simpler — and superior — explanations for why price growth remained above the Fed’s target than the deficit. Housing inflation has not moderated as quickly as many economists expected, although White House models predict it will do so soon. Price growth in auto insurance, financial services and medical services are indeed one-offs that are keeping inflation high now, officials said, but they will not continue to drive up prices in the coming months.
“It’s not really a tax issue,” Bernstein said.
