“We’ve averaged less than 2 percent inflation for more than the last 25 years,” Powell told lawmakers recently. “Inflation dynamics do change over time, but they don’t change on a dime.”
Biden has proposed a spending plan of more than $2 trillion for the nation’s infrastructure, which also includes everything from building child-care facilities to boosting Medicaid funding. It comes on top of the $1.9 trillion Covid relief package he signed last month and the $900 billion in spending that Congress approved in December. Yet another spending plan will be released this month.
While administration officials have dismissed the cautions about the potential for outsized inflation, the spending spree has clearly been accompanied by a newfound openness to the possibility of some upward pressure on prices, a stance that has drawn fire even from some Democrats like former Treasury Secretary Larry Summers.
“It’s very easy to make the mistake of thinking that what one hasn’t seen in a long time will never be seen again,” Summers said in an interview. “And it’s usually a better bet to think that things cycle around.”
But Powell and Treasury Secretary Janet Yellen argue that the risk of having too much inflation is much lower than of not having enough. That’s because the economy has radically shifted in the past 50 years.
The double-digit inflation last seen decades ago — during Jimmy Carter’s administration — wasn’t just the result of aggressive government spending. It stemmed from a variety of factors, including spiking oil prices, an ill-fated White House effort to cap wages and prices and a shift in U.S. dollar policy. And then there were the demographics — young, big-spending Baby Boomers with newly bought homes and double-income households as women entered the workforce in droves.
Now, if anything, the structure of the global economy is pushing prices down in advanced economies like the U.S., with low inflation often attributed to the rapid growth of international trade, automation and the internet (sometimes called “the Amazon effect”).
Demographics are also part of the story today: People in richer countries are having fewer babies and therefore their populations are getting proportionately older.
“Most people over a certain age just don’t need as many goods,” said Constance Hunter, chief economist at KPMG. “You’ve already furnished your house. You’re not commuting to work.”
“When you look at countries like Japan, for example, the dominant feature of their economy with regard to demographics is that they just don’t have enough demand to generate inflation,” she said.
For now, some signs of inflation are starting to appear, a phenomenon that the Fed forecasts will be temporary while the economy transitions back into being fully open. U.S. producer prices surged in March, the largest annual gain in nearly a decade, and other inflation gauges in coming months are expected to be similarly strong. That’s feeding Republican warnings about the dangers posed by big government spending.
Sen. Pat Toomey (R-Pa.), the ranking member on the Banking Committee and a longtime critic of ultra-low interest rates, called it “the latest troubling indication that inflation is starting to pick up.”
“Despite the economy recovering, 2021 growth projections of over 6 percent and steady employment gains, the Federal Reserve continues to keep interest rates at zero while purchasing almost $1.5 trillion worth of bonds annually,” he said in a statement Friday. “The Federal Reserve maintains that this bout of inflation will be mild and temporary. It may be time for the central bank to consider the alternative.”
But instead of getting too worked up about the prospect of inflation, the Fed is seeking a balance between the lessons of two different eras: the Great Inflation of the 1970s, when annual inflation rates soared as high as 13.5 percent, and the long but slow recovery after the 2008 financial crisis. When the Fed unleashed its bond-buying programs for years after the last recession, lawmakers such as Toomey raised concerns about inflation pressures that never took hold.
Either way, if inflation does start to really take off, the Fed should have plenty of time to react.
“It’s called the Great Inflation because it’s really like a 15, 16-year process. It’s a prolonged, gradual buildup,” said David Beckworth, a senior research fellow at the Mercatus Center at George Mason University.
Today, markets aren’t even pricing in significantly higher inflation, perhaps still expecting the Fed to flinch and raise rates at the first sign of trouble, despite its promise to hold steady until the economy reaches full employment.
Spending habits, wages and prices are all tied in part to the psychological phenomenon of whether people expect inflation to pick up, making those types of signals key to spotting the early signs of even slightly higher inflation. “I don’t even see us in the first stage of the Great Inflation,” Beckworth said.
The first stage began in the latter half of the 1960s, when inflation inched up alongside rapid economic growth and low unemployment. Before the shift to ’70s-era “stagflation” — economic stagnation plus inflation — then-Fed Chair Arthur Burns was pressured by President Richard Nixon in the lead-up to the 1972 presidential election to keep interest rates low.
“That was a great lesson of the ’60s and throughout the ’70s: policymakers, particularly at the Fed, kind of abdicated their responsibility for controlling inflation,” said Michael Feroli, chief U.S. economist at JPMorgan Chase.
The growing consensus, including within the Fed itself, is that it overcorrected in the decades after the Great Inflation by being too aggressive in trying to stave off higher price levels. After the 2008 financial crisis, the central bank raised rates before economic growth reached all corners of the labor market, even though there was no sign of inflation picking up. That’s now viewed by many economists as a policy error.
A new paper from the Groundwork Collaborative, a progressive activist group, criticizes how estimates of “full employment” have often accepted as normal that certain racial groups will have disproportionately high unemployment rates. They also argue that insufficient federal spending and tight money policies from the Fed have hurt more than just workers’ wages.
“If labor is never scarce and wages remain stagnant, there is less pressure to invest in labor-saving technologies that raise productivity growth, even when interest rates are relatively low,” according to the paper by economists Adam Hersh and Mark Paul.
Conscious of these negative ripple effects, the Fed launched a new framework under which it would push for slightly more inflation, to allow the unemployment rate to drop lower than it otherwise would be able to.
Now, both Congress and the Fed are working together to juice the economy in the hopes of achieving faster growth and that tick up in inflation that the central bank is looking for.
Skanda Amarnath, director of research and analysis at Employ America, noted that the spending under Biden is expected to be spread out over several years and could boost the economy’s overall productivity — growing supply along with demand. “That’s going to be something that takes a lot of time to fully materialize,” he said. “It doesn’t necessarily have to show up as inflation, and if it does, I think it will be pretty modest.”
But the Fed hasn’t entirely forgotten the lessons from 50 years ago. Powell has promised that the central bank won’t hesitate to stifle concerning levels of inflation, rather than repeating its past mistakes.
If inflation seemed in danger of rising too rapidly, “we would react, of course,” he said at an International Monetary Fund event on Thursday. “That would be our job.“