No end in sight for the debate over inflation

The debate over the Biden’s administrations proposed stimulus I discussed a few weeks ago is still going. If you wanted to keep up to date, here are some useful links:

The debate still hinges around three technical questions:

  • How large is the output gap? This is the gap between what an economy can theoretically produce, and what it is producing today. Think of the gap as representing idle factories or unemployed workers. The larger the gap, the more stimulus can be applied before you hit ‘supply limits,’ and cause inflation.
  • How effective will the stimulus be? Stimulus does not automatically create the demand which fills the output gap. Instead of buying a new TV, people might save the money they receive, or use it to pay down debts. Those who are concerned expect most of the stimulus to be spent, those who are more sanguine, the opposite.
  • How will inflation behave if it arrives? Both camps agree there is likely to be some inflation, but they disagree over how it will evolve. Those in favour of the stimulus as it stands expect inflation to steadily increase, perhaps even to 2% or 3%. They see this as a good thing, given inflation has been below target for almost a decade. There is little risk of it getting out of control because the Fed can always raise rates in the last instance.

    Pessimists are concerned that if inflation starts growing, it could quickly get out of control. Instead of growing to 2% or 3% and stabilising, expectations might change, causing inflation to continue higher. If the Fed has to react by rapidly raising rates, it could have negative consequences for the financial sector and the wider economy.

This says nothing about the politics around the stimulus. Biden does not want to run the risk of delivering an underpowered stimulus as Obama did after the GFC.


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