Roaring Back Or Overheating?
If you missed last Thursday’s debate on US fiscal stimulus, here’s the recording. Ellen Zentner (Morgan Stanley), Gregory Daco (Oxford Economics) and I touched on a number of topics, with a healthy degree of disagreement and the excellent orchestration of OMFIF’s Mark Sobel. I promise you’ll enjoy it; and while I can’t do justice to Ellen’s and Greg’s arguments, I do want to highlight some of the key points and questions that emerged:
How do you judge whether this fiscal stimulus is too large? Both Ellen and Greg argued that if you sum together the various fiscal packages launched last year and this year, you should not compare them to a snapshot of the current output gap, but to the cumulative loss in output over the crisis. If you do that, the overall fiscal stimulus is still significantly larger than the output loss, but not by orders of magnitude.
Both Ellen and Greg project a benign rise in inflation, to around 2½%, which Ellen predicts will prove long-lasting. That would be great. I am a bit more worried; as economists we tend to project moderate and smooth changes, but economic and financial variables often move a lot more and much more abruptly.
What will limit the increase in inflation? Greg notes that inflation expectations are well anchored, and that wage pressures are unlikely to rise much, given that they remained muted even when unemployment was at 3½%; Ellen is confident that government and Fed will tighten policy when needed.
I disagree on both counts. The Fed has committed to let inflation run above target for a while – we don’t know what will happen to inflation expectations when inflation rises and policy remains loose;
As for fiscal policy: a participant in the Q&A noted that after the large 2021 fiscal stimulus, just reverting to ‘normal’ fiscal policy next year would imply a massive fiscal tightening – and to me that seems unlikely as we head to midterm elections in November 2022. I think loose fiscal policy will be with us for a while.
Innovation could boost productivity and offset inflationary pressures. I think there is a lot of productivity-boosting innovation in the pipeline, and the pandemic has accelerated innovation efforts across the economy; but it will take more time – I don’t see it materializing in time to match this fiscal stimulus.
Both Greg and I think the promised infrastructure package could help boost productivity; Greg is a lot more confident that it actually will, I am more skeptical that the money will be spent well.
I am also concerned that this massive stimulus might actually undermine productivity: The BIS has found that credit bubbles cause a misallocation of resources that lowers productivity growth, and well…here we go again.
My overriding concern is that policymakers seem to have embraced the idea that there is no binding limit to fiscal stimulus – and if governments feel they can spend as much money as they want, they are unlikely to spend well.
Finally, we all think the tug-of-war between the Fed and the markets will get more intense in the coming months as the recovery takes off.