A study released in January 2022 by the Federal Reserve Bank of St. Louis concludes that 2.6 percent of the U.S. inflation rate for the 12 months ended February 2022 was due to COVID-related fiscal stimulus. This represents about one-third of the rampant 7.9 percent inflation experienced for the period.
The St. Louis Fed’s methodology did not include the inflationary impact of the increase in the supply of money due to Treasury borrowing and Federal Reserve monetization of this debt, but rather focused on the increase in aggregate demand caused by fiscal spending, which seems to be a relatively conservative approach to the data. Other economists argue that the enormous increase in the money supply caused by government spending is the major driver of the high inflation that we have experienced.
Three important conclusions can be derived from the St. Louis Fed study, the last and most important of which is that while the Fed has been battling to reduce inflation by raising interest rates, the Biden administration has been working at cross purposes to boost inflation by increasing government spending.
The first conclusion is that President Biden’s repeated denials in 2022 that government stimulus had any significant impact on inflation are simply incorrect. The period covered by the St. Louis Fed’s study ended in February 2022, the month in which Russia invaded Ukraine, and therefore did not include much of the inflationary impact on energy and other prices caused by the conflict. But prior to the invasion, the Biden administration attributed inflation largely to transitory supply chain problems. While supply chain issues undoubtedly added to inflation, and the invasion of Ukraine boosted it further, the Fed study makes it clear that fiscal spending had a major impact as well.
Some of this fiscal stimulus was necessary to stave off financial disaster after political authorities shut down the economy in 2020, causing businesses to close, workers to stay home and households to suffer huge income shortfalls. Our country had never before faced such a potentially dire situation — a health crisis followed by an almost total shutdown of the economy. Prices in almost every market plummeted.
Recall what a frightening time it was. First, we feared for our lives. Then, we feared for our livelihoods. In such an unprecedented situation, the government responded appropriately by increasing stimulus spending in the form of the $2.9 trillion dollar aid packages passed by Congress in 2020 and the 36 emergency Treasury and Federal Reserve programs designed to pump liquidity into the economy. These actions taken by the Trump administration prevented an economic and human catastrophe. But when the crisis had largely abated in early 2021, the Biden administration elected to further increase stimulus through its $1.9 trillion American Rescue Plan and its continuation of stimulus programs that were no longer needed. The rise in inflation caused by the 2020 stimulus was necessary but the continued increase resulting from the 2021 stimulus was not.
The second lesson we can draw from the Fed study is that the claim of progressives who embrace so-called modern monetary theory, which holds that governments using fiat currency can borrow, print money and spend freely without significantly raising inflation or suffering any other adverse consequence, is the nonsense that it sounds like. Any consumer with a household budget or any person with common sense could tell you that and the St. Louis Fed study underlines this important point.
Apologists for modern monetary theory argue that had taxes only been increased, inflation could have been contained. This ignores the fact that raising taxes was not politically feasible and that in view of the large segments of the population that received government stimulus, for tax increases to lower demand for goods, such increases would have to have been broad-based and not just applicable to the wealthy. This is something no progressive would advocate. It, therefore, comes as no surprise that proponents of modern monetary theory have been largely quiet for the past year. In economics, nothing is free and there is always a price to be paid.
Finally, and most importantly, in 2023, we are in a period when the Federal Reserve is raising interest rates at a record pace to decrease inflation. At the same time, the Biden administration is doing all that it can to deliver further stimulus to the economy, by among other things, plans for forgiving payments on student loans, extending the child tax credit, increasing health care subsidies and subsidizing “green energy.” These increases in spending, if implemented, are certain to increase the rate of inflation just as the St. Louis Fed found the COVID stimulus did. This raises the unfortunate image of the federal government at war with itself. While the Fed seeks to lower inflation, the Biden administration is pursuing policies that will inevitably cause inflation to rise.
Howard B. Adler, an attorney, served as deputy assistant Treasury secretary for the Financial Stability Oversight Council, 2019-21. He is the co-author of ”Surprised Again! The COVID Crisis and the New Market Bubble.”