This week on Facing the Future, we discussed the inflation outlook with Jason Furman, former chair of the President’s Council of Economic Advisors from 2013-17, and now a professor at Harvard’s Kennedy School of Government. Concord Coalition Policy Director Tori Gorman and our Chief Economist Steve Robinson joined me for the conversation.
The U.S. Bureau of Labor Statistics recently reported that inflation rose at an annual rate of 7.0% in 2021. It was the largest jump in 40 years. Up until recently, many policymakers believed that rising inflation, if a problem at all, would be transitory. But as inflation has spiraled upwards, they have dropped the word “transitory” and begun to contemplate inflation-fighting policies. Still, there seems to be a general consensus that things will settle down again in 2022. Furman is not so sure. In a recent Wall Street Journal op-ed he gave four reasons why inflation might stick around longer than anticipated.
“I pin roughly half of most of the inflation we see today on the fallout from the pandemic. It is a global phenomenon, there are global supply chains,” said Furman. “I’d pin the other half of it on fiscal policy being excessive. We needed a really large response to the crisis – it was a huge one. We got a response that was probably a trillion dollars more than we needed, and that’s fed into inflation. I think the Fed has been a little bit behind the curve, but that’s probably not affecting the inflation numbers yet, because monetary policy really matters with a lag. What the Fed does today matters for inflation a year from now. And so, the Fed probably should have adjusted more quickly, but even if they had, we’d be in roughly the same place right now.”
Furman says despite the fact that the federal COVID relief spigot supplying Americans with emergency cash during the pandemic has stopped flowing, there are a few reasons why economic demand will continue to be strong, adding to inflationary pressure.
“People got a lot of these transfers and they didn’t spend all of them,” said Furman. “In 2020, people cut back on their spending on travel, restaurants, movies, and all sorts of things. That means people have more cash today than they did going into the pandemic. So they still have the ability to spend more. Second, the federal fiscal response is mostly over, but states are flush with cash, and you are seeing more states increase spending or cut taxes. Third is the fact that interest rates have been so low and for certain types of interest sensitive spending, especially cars and houses, that really matters and that’s through the central bank. And finally I think there is some pent-up demand, especially for services. People are to some degree taking more vacations and as soon as it feels much safer than it does now, will take a lot more.”
As for what higher inflation might mean for the labor market, Furman says even though we haven’t seen a spiral of higher wages leading to higher consumer prices in 40 years, it may happen in 2022 with a tight labor market leading to higher wages. If such a wage/price spiral happens, however, Furman predicts it will have a more muted impact than many fear. He says it is important for the Fed to maintain its credibility and start acting soon to counter inflationary pressures by raising interest rates, but should be careful not to overreact and send the American economy into a recession.
“They are probably going to raise interest rates starting in March,” said Furman. “Any time interest rates – the Fed funds rate, the one that the Fed targets – is below 2 or 2.5%, that’s like having your foot on the accelerator. Any time it’s above 2.5% that’s like tapping on the brakes. Right now, we have the accelerator down all the way with interest rates at zero. They should over the course of this year get them to 1% and next year get them to 2% and then the foot will be entirely off the gas. They absolutely have to be watching the speedometer, watching the hills as we go up and down, and be prepared to do potentially more than that or possibly less than that, depending on what circumstances warrant.”
Furman says as long as inflation stays closer to 4% for 2022, the risk of higher interest rates pushing the American economy into recession will be lower. Higher inflation is also having a chilling effect on President Biden’s Congressional agenda, with his signature legislative agenda item – the Build Back Better Act (BBBA) – currently stalled right now and the President recently conceding that in order to pass the social spending and climate change package it may need to be broken up into smaller pieces. Furman – who supports BBBA – says inflation is not a legitimate reason for any member of Congress to withhold support for the domestic spending package. To Furman, the positive structural economic impact of the legislation far outweighs the much smaller risk that it may add inflationary pressure.
Furman says the bill should be more focused and consist of programs funded permanently. “As an economic matter,” he said, “having programs that are permanent rather than temporary is much better and maybe they should add some deficit reduction to the bill as part of the prioritization – maybe for economic reasons if not for political ones.
Hear more on Facing the Future. I host the program each week on WKXL in Concord N.H., and it is also available via podcast. Join me and my guests as we discuss issues relating to national fiscal policy with budget experts, industry leaders, and elected officials. Past broadcasts are available here. You can subscribe to the podcast on Spotify, Pandora, iTunes, Google Podcasts, Stitcher, or with an RSS feed. Follow Facing the Future on Facebook, and watch videos from past episodes on The Concord Coalition YouTube channel.