Inflation concerns put Biden, Fed on defensive

The Biden administration and Federal Reserve officials are seeking to keep inflation fears in check amid a sprint to approve nearly $2 trillion in coronavirus relief and economic aid.

With congressional Democrats likely to approve Biden’s relief plan within weeks, Biden’s economic team and Fed leaders are attempting to quell concerns that a new injection of aid could end up overheating a deeply damaged economy on the other side of the recovery.

Republicans are opposed to adding to the federal debt through another large COVID-19 relief bill after spending more than $4 trillion last year to respond to the crisis. But even some center-left economists are now arguing that Democrats are underestimating the chances that Biden’s rescue package, combined with the likelihood of increased spending from pent-up demand, could spur dangerous price and wage increases as the economy reopens.

Wall Street has also started walking back months of exuberance over Biden’s stimulus push. Treasury bond yields have risen while highly valued stocks have fallen in recent days, a sign that the Fed might be forced to raise rates to fight inflation earlier than expected.

“As soon as people become comfortable going back out to restaurants, taking vacations, going on cruises and doing all the things that they haven’t done before, that savings is going to be released into the economy,” said Peter Cecchini, chief strategist at investment research firm AlphaOmega Advisors.

“You’re going to see certainly a massive spike in GDP, but I would suggest at least a one-quarter [point] jump in inflation.”

Despite concerns like those, Biden’s economic team is adamant that inflationary risks are much smaller than the damage that would come from not spending enough to support millions of jobless Americans and fill the void left by thousands of bankrupted businesses.

“If you don’t spend what it’s necessary to get the economy quickly back on track, that has a fiscal cost as well,” said Treasury Secretary Janet Yellen during a Monday virtual conference hosted by The New York Times.

“We have more fiscal space than we used to because of the interest rate environment, and I think we should be using it now to regress in an emergency.”

Fed officials are doubtful that the U.S. will see inflation rise on a steady basis until well after 2021, given the depth of economic damage caused by the pandemic.

Inflation has been well below the Fed’s 2 percent annual target since long before COVID-19 derailed an economy enjoying its lowest unemployment rate in 50 years. The Fed has ample room to hike interest rates in front of inflation with its baseline rate set near zero percent, and the central bank has embraced the need to let price and wage increases rise faster than its target rate to catch up on years of misses.

“We’ve seen really the last decade be characterized by global disinflationary forces and large advanced economies, nations struggling to reach their 2 percent inflation goal from below,” Fed Chair Jerome Powell said during a conference earlier this month.

“Nothing in the economy is really permanent,” Powell added. “Inflation dynamics will evolve, but it’s hard to make the case why they would evolve very suddenly in this current situation.”

Nearly a year after COVID-19 roiled the economy, U.S. policymakers and economists are grappling with how much more aid the country needs to make it through what remains of the pandemic.

Economists broadly agree that once the U.S. achieves herd immunity — potentially by mid-summer — the economy will kick back into gear. But how sharp that recovery will be is far from settled.

Biden’s economic team and Fed officials insist that the U.S. must go big on coronavirus relief to compensate for how long it could take to heal pandemic scars.

Biden and supporters of his approach say the U.S. can’t afford to make the same mistake it did amid the Great Recession, which was followed by a sluggish recovery that many Democrats blamed on insufficient stimulus and premature spending cuts.

“At this point in the Great Recession … there was so much we thought we knew about what was going to come in the recovery that ended up being very different,” said Claudia Sahm, a Fed research director and economist from 2007 to 2019. “The more we do now, the faster we get back on our feet, the faster we get back to something that looks like maximum employment.”

Unlike in 2009, concerns over the national debt have done little to impede the push for stimulus. Democrats are attempting to pass their relief bill through the budget reconciliation process, and even nonpartisan fiscal hawks say a big investment in stimulus now is essential to building the strength needed to pay down the debt later.

Opponents argue Biden and his supporters could be underestimating the power of lingering Trump administration stimulus.

Former Treasury Secretary Larry Summers and former International Monetary Fund Chief Economist Olivier Blanchard are among those from the center-left who have warned of inflationary risks stemming from Biden’s proposal, drawing citations from Republicans and backlash from Democrats. They called for a smaller, more targeted relief bill and warned that sending stimulus checks to households that may not need them will pose unnecessary risks.

The personal savings rate grew to 13 percent in December — nearly twice its pre-pandemic level — according to federal data. Another round of stimulus checks is likely to boost that level, and inflation hawks fear it could fuel a surge of demand in an economy not equipped to satisfy it.

“Clearly folks who are not struggling, who were above the median household income are getting this stimulus and they’re saving it,” Cecchini said, adding that stimulus efforts should instead be focused on the unemployed and households that have taken severe financial hits due to the pandemic. “If all this money is getting saved, how can that possibly be going to the people who need it most?”

Biden has said he is open to narrowing income thresholds for the next round of checks, but the president and his team say it’s essential to cast a wide net to limit the number of households that slip through the cracks.

“We need to make sure that those who’ve been most affected aren’t permanently scarred by this crisis, that they can go back to leading productive lives,” Yellen said Monday. “There are pockets of pain that go beyond what can be reached in those highly targeted ways.”