BEYOND THE NUMBERS
Well-designed legislation that supports the economic future of families, workers, and children while at the same time reducing deficits would have little if any effect on aggregate demand for goods and services that would raise inflation concerns. Moreover, legislation that includes measures to improve access to health coverage and child care, to provide more income support to help the lowest-income families with children to cover basic costs, and to address climate change would deliver substantial benefits.
It would have little, if any, impact on aggregate demand. Recent high inflation reflects strong growth in the demand for goods and services bumping up against constraints on the supply of those goods and services. The result has been rising prices, which the Federal Reserve must address. However, a modest-sized, targeted economic package would spread investments relatively evenly over the next decade and include revenue increases and spending reductions — similarly spread over the decade — large enough to fully pay for the investments and also reduce the deficit. In an economy with cumulative gross domestic product (GDP) over the coming decade of roughly $300 trillion, such a package would likely spend less than 0.5 percent of GDP and include enough offsets to reduce the deficit, and therefore would not have a noticeable effect on aggregate demand.
It would come at a time when the expiration of pandemic-related relief and stimulus measures is causing a significant drag on aggregate demand. This year the economy began to face fiscal headwinds from the expiration of past measures that will dwarf any inflationary pressure from a well-designed and paid-for economic package. Federal, state, and local tax and spending policies added 5.35 percentage points to GDP growth between the first quarter of 2020 and the first quarter of 2021, according to the Hutchins Center at Brookings. But in the four quarters since then, the waning of tax and spending measures subtracted 2.72 percentage points, Hutchins estimates — a swing of over 8 percentage points — and such subtraction will continue into 2023. Going forward, this drag is a force reducing inflationary pressures.
The impact of this swing in fiscal policy will vastly outweigh any impact from a well-designed economic package that reduces the deficit.
Analysts in this Wall Street Journal article drew similar conclusions:
Looking just at federal policies, David Mericle, chief U.S. economist at Goldman Sachs says, “By the fourth quarter of 2021, the various Covid-19 relief packages enacted since 2020 had boosted the level of U.S. GDP by just under 6 percentage points…[but] by the end of 2022 that boost will shrink to a little less than 2 percentage points, … equivalent to 4 percentage points of drag on economic growth compared with what would have been if pandemic programs offered the same support as in 2021.
Joseph LaVorgna, chief economist for the Americas at Natixis, forecasts even lower growth, of around 1.5%, mostly because of waning fiscal support. “I think it is fair to say that the fiscal shock is going to be in historic proportions,” Mr. LaVorgna said.
Similarly, Federal Reserve Chair Jerome Powell pointed out in January that “fiscal policy is going to be less supportive of growth this year.” In other words, the economy can still grow but that growth will come from non-government demand, not fiscal policy.
By promoting growth over the long term, it could reduce inflationary pressure. Over time, investments that increase the economy’s capacity to produce goods and services would lead to higher productivity and stronger non-inflationary growth. Policies under discussion for an economic package, such as improved access to health care and child care and improved income support for low-income families with children, have been shown to have long-term benefits. For example, child care can increase the labor supply in the short term and improve children’s longer-term outcomes in ways that increase future productivity. Also, clean-energy investments can mitigate the economic costs of climate change. Seventeen Nobel Laureates in Economics have explained how future-oriented investments and tax reform that makes the tax system more equitable would ease longer-term inflationary pressures.
The Federal Reserve has primary responsibility for addressing inflation and is taking the steps necessary to do so, including yesterday’s announcement of a half-point increase in interest rates. An economic package of modest size that addresses critical needs and reduces the deficit would not hamper the Fed’s efforts. It would, however, have a large and positive impact on the lives of the people who receive the benefits.