Here’s why spending $2T won’t make inflation worse than it already is | Opinion
By Michael Klein
One of U.S. Sen. Joe Manchin’s main concerns in deciding to pull his support for President Joe Biden’s Build Back Better plan is that it would drive up inflation, which is currently rising at the fastest pace in four decades.
On Dec. 19, 2021, the West Virginia Democrat said in an interview that he couldn’t support the bill in its current form because of the impact he says it would have on increasing consumer prices and the national debt. The decision effectively killed one of Biden’s top economic priorities.
The Senate had been considering the roughly $2 trillion bill passed by the House that would spend money on health care, education, fighting climate change and much else over the next decade. Senate Majority Leader Chuck Schumer, D-N.Y., says he still plans to bring it to the floor for a vote.
Manchin and Republicans have argued the risk that more spending could push inflation even higher is too great.
As an economist, I believe Manchin’s concerns are misguided. Here’s why.
Putting $2 trillion in context
High inflation is clearly a problem at the moment – as the Federal Reserve’s Dec. 15, 2021, decision to accelerate its withdrawal of economic stimulus signals.
The most recent statistics show inflation, as measured by the annual increase in the Consumer Price Index, was 6.8% in November 2021. This is the highest level since 1982 – yet still a long way from the double-digit inflation experienced back then.
The question, then, is: Could an additional large spending increase cause inflation to accelerate further?
To answer this, it’s useful to put the numbers in some context.
The price tag of the Build Back Better plan passed by the House of Representatives is about $2 trillion, to be spent over a 10-year period. If the spending is spread out evenly, that would amount to about $200 billion a year. That’s only about 3% of how much the government planned to spend in 2021.
Another comparison is to gross domestic product, which is the value of all goods and services produced in a country. U.S. GDP is projected to be $22.3 trillion in 2022. This means that the first year of the bill’s spending would be about 0.8% of the GDP.
While that doesn’t sound like much either, it’s not insignificant. Goldman Sachs had estimated U.S. economic growth at 3.8% in 2022. If the increased spending translated into economic activity on a dollar-for-dollar basis, that could lift growth by over one-fifth.
But what really matters here is how much the bill would spend in excess of any taxes raised to pay for the program. The higher taxes on the wealthy and corporations that the House version of the bill calls for would reduce economic activity – by taking money out of the economy – offsetting some of the impact of the spending that would stimulate it.
The Congressional Budget Office estimates that the bill would increase the deficit by $150.7 billion over a decade, or about $15 billion a year. Again assuming this is spread evenly over the 10 years, it would amount to less than one-tenth of 1% of GDP. Even if elements of the bill are front-loaded, it does not seem that this increase in the government debt would contribute much to inflation.
In other words, the proposed spending would make a barely noticeable macroeconomic effect even if it had an unusually disproportionate impact on the economy.
But it won’t reduce inflation either
Some proponents of the bill – including the White House and some economists – have gone further. They have argued that the proposed spending package would actually reduce inflation by increasing the productive capacity of the economy – or its maximum potential output.
This seems implausible to me, at least given the current level of inflation. Historical evidence shows a more productive economy can grow more quickly with relatively little upward pressure on prices. That’s what happened in the U.S. in the 1990s, when the economy grew strongly with little inflation. But it takes time for investments like those in the bill to translate into gains in productivity and economic growth – meaning many of these impacts will be slow to materialize.
And current inflation is likely an acute problem reflecting supply chain disruptions and pent-up demand, challenges that won’t be resolved by expanding the economy’s productive capacity five or more years down the road.
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At the same time, what’s in the bill would make a big difference to improving the lives of average Americans by providing more of them with affordable child and health care and reducing child poverty – areas where the U.S. seriously lags behind other rich countries. And it would help the U.S. fight the ever-worsening effects of climate change.
While the $2 trillion in spending would be unlikely to worsen inflation if it were to become law, I believe it could do a lot to materially address these challenges America faces.
This is an updated version of an article published on Dec. 16, 2021.
Michael Klein is a professor of International Economic Affairs at The Fletcher School at Tufts University. He wrote this piece for The Conversation, where it first appeared.
Originally published at www.penncapital-star.com,by Capital-Star Guest Contributor