A different kind of fluke
Just how anchored are America's inflation expectations
Since democrats proposed a $1.9trn fiscal stimulus in January, hawks have warned that America's economy might overheat. With cheques for $1,400 now landing in bank accounts, President Joe Biden reportedly considering spending another $3trn on infrastructure and the Federal Reserve showing no sign of putting the brakes on the rebound from the pandemic, the predictions of impending doom are getting louder. The latest was delivered by Larry Summers, a former treasury secretary, on March 20th. Mr Summers sees it as more likely than not that the economy will suffer either from an inflation surge or from the crushing effects of higher interest rates. America, he says, has the least responsible economic policy in 40 years.
The worst-case scenario painted by inflation hawks can be broken into stages. First, inflation will soon rise mechanically as numbers from the spring of 2020, when the economy and commodity prices slumped, fall out of comparisons with a year earlier. On that everyone agrees.
The next phase is a second wave of inflation as spending by newly vaccinated-consumers rebounds from the pandemic faster than production can keep up. Even stimulus advocates typically admit that overheating is a risk, and it would be more likely should more deficit spending pass. Mr Biden may unveil the spending side of his infrastructure bill alongside his preliminary annual budget proposals for government departments, which are due next week. Whereas some of any Biden infrastructure bill may be paid for by raising taxes, it seems unlikely that Congress would raise $3trn this way, rather than relying on at least some extra borrowing.
It is the last stage of the doomsday timeline that is most controversial, in which temporary inflation turns permanent as the public's inflation expectations rise and become self-fulfilling. Workers, anticipating a higher cost of living, demand higher pay; forward-thinking firms raise prices. The result would be a return to the 5% plus inflation of the late 1960s, or perhaps even the 10%-plus rates of the 1970s.
In recent decades the grip of the Fed on inflation expectations seemed ironclad. Even when in 2019 unemployment plumbed depths not seen since the 1960s, inflation expectations did not stir very much. In theory that makes all inflation surprises temporary. "Having (inflation expectations) anchored at 2% is what gives us the ability to push hard when the economy's really weak," said Jerome Powell, the Fed's chairman, on March 17th.