Overall, I like the way this article in The Week explains how the government spending since the start of the Covid recession, followed by the infrastructure and social spending being proposed now, is likely to be inflationary.

It’s likely, though, that the massive COVID relief bills were the primary culprit. While a supply shock should lead to price spikes, it should also lead to a fall-off in demand as people adjust their overall budgets to higher prices. When people have to spend more on gas and groceries, they should spend less on other goods. That’s not what we’re seeing though: demand remains extremely robust. People are complaining about price increases, but they aren’t cutting back. This is precisely what you would expect if household balance sheets were in generally excellent shape, as in fact they are; if there were lots of pent-up demand due to the pandemic, as in fact there is; and if people were beginning to assume that higher prices were becoming normal — which, if they are, is precisely how you get a self-reinforcing inflationary spiral as opposed to something more “transitory.”

That doesn’t mean those bills were a mistake. The risk really was higher in under-shooting than in over-shooting, and so the government erred on the side of over-shooting and over-shot. It just means that policy going forward has to respond to the new economic situation. Stimulative spending now has a downside of further boosting inflation, and therefore encouraging the Federal Reserve to hike rates faster. Inasmuch as the reconciliation bill’s spending will be stimulative — and its major components like the expanded child tax credit certainly will be — that’s a problem.

The Week

Put another way (not the way this article puts it), the new government spending being proposed is necessary, but right now, with the private economy suddenly heating up, might not be the best time for it. The political system is hopeless about getting the timing right. By the time politicians react to a situation, go through an election cycle, and negotiate a new deal (pun somewhat intended?), conditions have already changed. While I am not an economic historian, this is my limited understanding of how the Kennedy administration managed to ramp up spending in an overheated economy in the 1960s, leading to the inflation crisis of the 1970s.

Monetary policy clearly helps, but “automatic fiscal stabilizers” are another way this problem could be tackled from the government spending end. Congress could pass its “big spending bills”, but tie distribution of the money to economic indicators like the unemployment rate. The Sahm index, which is basically a ratio of the current unemployment rate to its average over the last year. is one metric that has been proposed for this. Using this rule would have turned on the taps in March 2020, then started to throttle back in January 2021 – this sounds about right, given that inflation started to ramp up suddenly in the second quarter of 2021! Congress could take this “set it and forget it” approach, and a future Congress could always undo it if they want, but it might just stabilize our economy and society to the point where it becomes the new normal.

I’ll try not to be cynical. Maybe our politicians are capable of understanding this, communicating it effectively to the public and business community to build support, and doing the right thing.

Okay, I can’t help being cynical – the Democrats will probably push ahead with their enormously beneficial but poorly timed spending bills, the public will benefit enormously from these bills but not give any credit to the Democrats, inflation will continue to ramp up, and the Republicans will fiddle while the economy burns going into the next election cycle.