Inflation may or may not be heating up, but the debate over whether it will is getting hotter.
While Congress negotiates another stimulus package with a price tag of up to $1.9 trillion, some economists are raising concerns that inflationary pressures will return to the economy.
Among those ringing the alarm bell are Larry Summers, the former treasury secretary under President Bill Clinton and a respected, if controversial, voice in macroeconomics.
“First, while there are enormous uncertainties, there is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation,” Summers wrote in The Washington Post. In a follow-up column he also said, “I worry that containing an inflationary outbreak without triggering a recession may be even more difficult now than in the past.”
With someone like Summers speaking up on the inflation debate, high-level officials in both the Federal Reserve and Biden administration have chimed in.
Treasury Secretary Janet Yellen has stressed that the risk of not passing the stimulus package far outweighed the risk of any future inflation.
"The most important risk is that we leave workers and communities scarred by the pandemic and the economic toll that it's taken," she said on CNN earlier this week. "My predecessor has indicated that there's a chance that this will cause inflation to rise, and that's also a risk that we have to consider. I've spent many years studying inflation and worrying about inflation, and I can tell you we have tools to deal with that risk if it materializes."
Those tools include winding down quantitative easing, issuing new guidances, and raising interest rates, which have remained near-zero for much of the crisis.
Fed Chair Jerome Powell has likewise maintained that the Fed will remain dovish until the economy is back on firm ground, and that means allowing some wiggle room or "transitory inflation" above the 2 percent threshold that used to be the ceiling for the central bank.
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Why is this debate returning now after multiple trillion-dollar fiscal stimulus packages? In part, it's because the total amount of stimulus just keeps adding up, and some argue there's a limit to what the economy can handle.
"We're looking at amounts that we've never really seen before in times of peace," Gregory Daco, chief U.S. economist at Oxford Economics, told Cheddar. "Granted, the dislocation from the COVID crisis has also been unprecedented."
Whatever the amount of the stimulus, Daco contends that you have to look closely at how the money will be spent before getting too worried about inflation.
"We cannot assume that as we put $1.9 trillion on the table, that that amount will end up going out the door right-off-the-bat," he said. "It is very likely that a big chunk of that amount will end up either in savings or paying down debt or being invested in financial markets."
Already, the savings rate is elevated. Americans in December saved 13.7 percent of their disposable personal income. That's down from a whopping 33 percent at the beginning of the pandemic in the U.S., but remains nearly double the average for the last 40 years.
In other words, the stimulus could be more of a trickle than a flood, at least when it comes to the broad money supply.
Daco noted that while there may be pockets of inflation, generally supply and demand will work these out. This applies to the broader threat of inflation as well, he added.
"We do not anticipate that supply would not respond to heightened demand," he said. "That's important to keep in mind because we've seen time and time again that whenever there have been pressures in terms of increased demand or rebounding demand, supply has responded."
Deflation vs. Inflation
In many ways, those worried about inflation are looking at just one side of what is a pretty complicated equation, explained Lyn Alden, who provides market research to investors.
"There's really two forces that we're dealing with. On the one hand, there's a really big deflationary force, which is a lot of debt in the system and the shock from the pandemic," she said. "On the other hand, the government response has been very inflationary."
Past government responses to economic crises haven't had such a direct impact on inflation, she added, because they were mostly focused on recapitalizing banks, not putting money into the hands of individuals or businesses — which is what happened after the 2008 housing crisis.
This partly explains in part, along with a number of structural factors such as high levels of debt, technological innovation, and off-shoring, why the U.S. economy did not see inflation even at the height of the Trump boom when unemployment had reached a 50-year low, she said.
The lessons of the last recession may not apply to the unique conundrum that is the coronavirus pandemic, however.
Alden said she is keeping an eye both on how Treasury Inflation-Protected Securities are factoring in inflation risk, which is a forward-looking measure, and movements in the Consumer Price Index, which lags with where the real economy is at.
She pointed out that inflation is really the only limit on spending for a currency-issuing government such as the U.S., which is one reason for revived debate.
"That's really the only limit they're working against here," she said. "They can kind of push things until they see inflation. But the problem is inflation comes with a lag, so you could push things too far and then find out six to 12 months later that it was actually inflationary."
Across the economy, there's a bit of schizophrenia when it comes to the inflation/deflation debate. On the one hand, inflation means a growing economy after the devastation of COVID. On the other, it would be a totally new environment for an economy used to next to none.
"Don’t get me wrong, inflation running ahead of 2 percent for a while would be a sign of a healing economy," said Lindsey Bell, chief investment strategist for Ally Invest. "But a surge in inflation is becoming more of a concern, and it could be a problem for your portfolio."