(Lauren Melodia and I had an op-ed in the Nov. 21 Washington Post, challenging the idea that today’s inflation means that the stimulus measures of the past year and half were too large. I’m posting it here as well.) As we think about rising prices today, it’s important not to lose sight of where we were not so long ago. In the spring of 2020, much of the economy abruptly shut down. Schools and child-care centers closed. Air travel fell below 100,000 people a day, compared with 2.5 million daily passengers in a normal year. No one was staying in hotels or going to the gym. About 1.4 million small businesses shut their doors in the second quarter of the year. More than 20 million Americans lost their jobs in the early days of the pandemic, and there was a very real possibility that many
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(Lauren Melodia and I had an op-ed in the Nov. 21 Washington Post, challenging the idea that today’s inflation means that the stimulus measures of the past year and half were too large. I’m posting it here as well.)
As we think about rising prices today, it’s important not to lose sight of where we were not so long ago. In the spring of 2020, much of the economy abruptly shut down. Schools and child-care centers closed. Air travel fell below 100,000 people a day, compared with 2.5 million daily passengers in a normal year. No one was staying in hotels or going to the gym. About 1.4 million small businesses shut their doors in the second quarter of the year.
More than 20 million Americans lost their jobs in the early days of the pandemic, and there was a very real possibility that many would face hunger, eviction and poverty. Many economists predicted a deep downturn comparable to the Great Recession that followed the financial crisis of 2007-08, if not the Great Depression of the 1930s.
Even at the start of this year, as Congress was debating the American Rescue Plan, it was far from clear that we were out of danger. In January, there were 10 million fewer jobs than a year earlier. Covid-related deaths were running at 30,000 per week — the highest rate at any point in the pandemic. No one knew how fast vaccines could be rolled out. There was still a real risk that the economy could tip into depression.
Thanks to stimulus measures, including the $2.2 trillion Cares Act, signed by President Donald Trump in March 2020, and the $1.9 trillion American Rescue Plan, signed by President Biden in March 2021, that didn’t happen. People who lost their jobs in restaurants, airports, hotels and elsewhere continued to pay their rent and put food on the table.
For much of 2020 and 2021, all the uncertainty — and the risks associated with vacationing, dining out and so on — meant households held back on spending, and savings piled up. Now, with the economy reopening and the worst of the pandemic (let’s hope) behind us, people are rushing to make use of those savings. Unfortunately, businesses can’t adjust production as fast as people can spend money, resulting in the inflation we’re seeing now: Prices rose 0.9 percent from September to October 2021 and are up 6.2 percent since October 2020.
It would be nice if there were a way to avoid economic catastrophe during the year-plus of pandemic restrictions while also avoiding rising prices today. But in the real world, there probably wasn’t. The pandemic imposed costs on the economy that had to be paid one way or another.
Think of it this way. When a restaurant shuts down for public health reasons, two things happen: Its services are not available for purchase, and the people who work there lose their incomes. If the government does nothing, aggregate demand and supply will remain in rough balance, but the displaced workers will be unable to pay their bills. Alternatively, the government can step in to maintain the incomes of the displaced workers. In this case, the spending that consumers might have done in restaurants will spill over into the rest of the economy — if not right away, then eventually. In a sense, the rising costs we’re seeing today are a result of economic production that didn’t happen last year.
In economics textbooks, the level of demand that brings the economy to full employment will also cause stable inflation — an assumption labeled “the divine coincidence.” But here on Earth, things don’t always work out so neatly. The level of spending required to replace incomes lost in the pandemic, combined with the disruptions to production and trade, meant there was no way to get an adequate recovery without some increase in inflation, especially given the bumps on the road to controlling the coronavirus. As the spread of the delta variant and some Americans’ resistance to getting a vaccine have held back spending on services, demand has spilled over into goods. And as it turns out, our global supply chains are unable to handle a rapid rise in demand for goods — especially because many manufacturers had expected a deep downturn and planned accordingly.
Today’s inflation has surprised many people, including us. We had been more worried about sustained high unemployment. One of us even gave a talk a year ago called “The Coronavirus Recession Is Just Beginning.” We were wrong about that. But then, so was almost everyone. In the summer of 2020, the Congressional Budget Office was predicting that the unemployment rate in late 2021 would be 8 percent; in fact, it has fallen to 4.6 percent. Many private forecasters were similarly gloomy. Under the circumstances, policymakers were absolutely right to prioritize payments to families.
The economist Larry Summers has been making the case since February that the government’s stimulus programs were larger than required and ran the risk of “inflationary pressures of a kind we have not seen in a generation.” Fiscal conservatives are claiming that Summers has been vindicated because inflation is higher than most supporters of the most recent relief package expected. But the economic data doesn’t match the scenario he described.
Summers predicted that the cumulative stimulus impact would be larger than the country’s output gap — the difference between actual and potential gross domestic product. Today, despite the stimulus, both real and nominal GDP remain significantly below the pre-pandemic trend. So unless you think the economy was operating above potential before the pandemic, there’s no reason to think it is above potential now. To the extent that domestic conditions are contributing to inflation, it’s not because spending has surpassed the economy’s capacity but because there has been a rapid shift in demand from services to goods.
In any case, most of the inflation we’re seeing is due not to domestic conditions but to the worldwide spike in food, energy and shipping costs. Perhaps we could have had inflation of 5 percent instead of 6 percent if the stimulus had been smaller. The cost of that trade-off would have been material hardship for millions of families and the risk of tipping the economy into a downturn. And that, fundamentally, is why today’s inflation is not a sign that the stimulus was too large: It has to be weighed against the risks on the other side.
After 2007, the United States experienced many years of high unemployment and depressed growth, thanks in large part to a stimulus that most now agree was too small. Policymakers belatedly learned that lesson, and as a result, the United States is making a rapid recovery from the most severe economic disruption in modern history. Yes, inflation is a real problem that needs to be addressed. In a recent Roosevelt Institute brief, we suggested that rather than raise interest rates, the best way to control inflation is to address supply constraints in the sectors where prices are climbing. But as bad as inflation is, mass unemployment is much worse. Given the alternatives, policymakers made the right choice.