Today’s favorable employment and GDP numbers, pointing to a U.S. economy well on the mend, have to raise a couple of basic questions.
With the US economy already recovering, did the U.S. economy really need as large a budget stimulus as the Biden Administration rushed through Congress earlier this month?
Might overstimulating the economy now not run the real risk of reviving our past inflation demons?
After today’s official economic releases, there can be little doubt that the U.S. economy is far from the depths to which it plummeted in the immediate aftermath of the Covid-19 pandemic’s onset. At 680,000 new claims, weekly jobless claims are now at their lowest level since the pandemic began. Meanwhile, in the fourth quarter of last year, GDP is now estimated to have grown by a satisfactory 4 ¼ percent or somewhat better than had been expected.
It would also seem to be clear now that the U.S. economy at the start of the Biden Administration was in very much better shape than it was at the start of the Obama Administration. Whereas today the unemployment rate is around 6 ¼ percent and the so-called output gap measured by the Congressional Budget Office is 3 percent, in March 2009 unemployment exceeded 8 ½ percent and the output gap had reached 6 ¼ percent.
The fundamental economic narrative that the Biden Administration is now spinning is that President Obama’s crucial economic policy mistake was to go too small in its budget policy response to the 2008-2009 Great Economic Recession. This condemned the US economy to its slowest post-war economic recovery. It also made the US economy overly reliant on an ultra-easy and unorthodox monetary policy to keep the recovery on track.
Not wanting to repeat the Obama policy mistake, Treasury Secretary Janet Yellen now keeps repeating the argument that it is better to go too big rather than too small in our budget policy response to today’s economic slump. This thinking has motivated President Biden to fast-track through Congress his recently approved $1.9 trillion budget stimulus package. Coming on top of the $900 billion bipartisan budget stimulus package, the Biden stimulus implies that in 2021 the US economy will be receiving budget stimulus amounting to a staggering 13 percent of the country’s Gross Domestic Product.
It is quite understandable that the Biden economic team does not want to repeat President Obama’s mistake of having gone too small in its budget policy response. However, what is not understandable is why it would want to make the opposite mistake of risking inflation by coming up with an excessively large budget policy response.
Among the factors that would point to the Biden budget policy response being excessive is the fact that it is roughly three times the size of 2009 Obama budget response. This is the case even though the US economy is now well on the way to recovery and is in very much better shape than it was in 2009.
Another factor that would suggest that the Biden budget stimulus is excessive is the fact that it is not occurring in isolation. Indeed, looking ahead, the U.S. economy must be expected to continue benefitting from the Federal Reserve’s unusually accommodative monetary policy stance. It must also be expected to get a big boost from the release of a very large amount of Covid-related pent-up household demand once most American’s are vaccinated by the middle of the year.
In sum, the Biden Administration’s approach to economic policy is reminiscent of an impatient person trying to get the room to the right temperature. After setting the thermostat too low, the person then sets the thermostat too high and, in the process, fails to get the room at the right temperature. By overcompensating for the Obama budget response having been too small in the last economic recession and by now going far too big at a time that the economy is already recovering, President Biden is risking economic overheating that will bring higher and unwelcome inflation in its wake.
Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund’s (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.