Biden’s rescue plan made inflation worse but the economy better

The Washington Post / David J. Lynch

16:18 JST, October 10, 2022

In a two-minute Oval Office ceremony in March of last year, President Joe Biden marked a major legislative accomplishment, signing the nearly $2 trillion American Rescue Plan, designed to free the U.S. economy from the pandemic’s grip once and for all.

Smacking his pen on his White House desk, a satisfied Biden exclaimed “Got it!” before rising to leave the room.

Though some experts – even in his own party – warned that the new spending could cause the economy to overheat, administration officials saw little reason for concern. Just one day earlier, the Labor Department had put annual inflation at a tame 1.7 percent.

Yet even as the president beamed, forces were stirring that would put the rescue plan at the center of a debate over whether he had blundered with his free-spending recipe for recovery, souring Americans on his stewardship of the economy and allowing Republicans to capitalize on the rising cost of living.

The political and economic consequences of Biden’s first landmark law will be debated for years. But 18 months later, there is a consensus that the rescue plan was a double-edged sword: Bathing the economy in cash spurred the fastest recovery of any Group of 7 nation, even as the indiscriminate nature of that spending helped ignite the biggest jump in consumer prices in 40 years.

While experts disagree about the extent of the rescue plan’s contribution to inflation, it seems clear that its role has been larger than the Biden administration concedes while falling short of the calamity that Republicans claim.

Within days of the March 2021 White House event, as the plan’s $1,400 stimulus checks landed in Americans’ bank accounts, prices for items such as used cars and airline and sports tickets began to rise. Today, annual inflation stands at 8.3 percent, near its highest mark in 40 years.

Even without the rescue plan, the United States would have experienced significant inflation because of the unprecedented dislocation brought on by the coronavirus. As economies around the world last year eased their pandemic restrictions, a surge of consumer spending collided with chronic supply problems to boost prices almost everywhere. Outbreaks of coronavirus variants and Russia’s invasion of Ukraine further aggravated tight markets.

But many economists have concluded that the rescue plan made U.S. inflation worse.

The highest estimate – that roughly half or about four percentage points of the recent increase in annual inflation can be attributed to the rescue plan – comes from Francesco Bianchi of Johns Hopkins University, who presented findings from a paper he co-authored at the Federal Reserve’s annual conference in Jackson Hole, Wyo.

Four economists at the Federal Reserve Bank of San Francisco in March put the rescue plan’s effect at three percentage points after comparing the U.S. experience to that of other advanced economies, which suggests that the law accounted for about 40 percent of U.S. inflation. And Laurence Ball of Johns Hopkins, along with Daniel Leigh and Prachi Mishra of the International Monetary Fund, arrived at a similar figure in a paper presented at a Brookings Institution conference in early September.

“We certainly could have had a world in which we had protected the economy and generated far less inflation,” said Lawrence Summers, a critic of the rescue plan who was President Barack Obama’s top economic adviser. “The likely consequence of the inflation we have run – in addition to substantial reductions in the real wages of workers – is going to be to bring on the next recession sooner than we otherwise would have had it.”

The Biden administration disputes these assessments, noting that some studies have found smaller effects. An October 2021 analysis by other economists at the San Francisco Fed, for example, which relied on a labor market measure of economic slack, concluded that the rescue plan was responsible for just 0.3 percentage points of added inflation.

The administration has conducted no formal assessment of the plan’s link to inflation. But officials note that the U.S. experience is not unique. Inflation in August was 9.9 percent in the United Kingdom; 9.1 percent in the euro zone; and 7.0 percent in Canada.

In an interview, Gene Sperling, the plan’s White House coordinator, insisted that the legislation’s benefits outweighed its costs.

“The American Rescue Plan came at a time when the recovery was still uncertain, Sperling said. “The unexpected hits from delta, omicron, Chinese lockdowns and an unthinkable war in Ukraine that has roiled global energy markets each or together could have derailed this recovery long ago without the cushion provided by more sustained recovery funding.”

Indeed, in the 18 months since the rescue plan was signed into law, the economic landscape has been transformed. More than 8 million Americans who were jobless in March 2021 are now working. The economy last year posted its fastest growth since 1984 and ended the year more than 3 percent larger than before the pandemic.

Determining the plan’s precise contribution to inflation is difficult. About $900 billion in plan spending occurred last year, hitting the economy like a shot of espresso. But the $25 trillion U.S. economy also was shaped by ultraloose Fed monetary policies, including interest rates near zero and trillions of dollars in asset purchases that further eased credit.

The result was an episode of sticker shock that was utterly unfamiliar for most Americans. Each month, it seemed, inflation spread into another corner of everyday life. In May, it was fuel oil. June, gasoline. July saw hot dogs and women’s dresses grow more expensive.

By the end of the year, just about everything cost more: men’s shirts and sweaters; bread and crackers; dishes, jewelry and rent.

Economists have struggled to untangle the forces that drove the inflation outbreak. The studies conducted to date employ various methodologies and make assumptions about how the economy works, which in some cases have been criticized as unrealistic.

Summers’s conclusion that the Biden plan was excessive rests on a Congressional Budget Office assessment of economic slack known as the “output gap.” But such estimates are notoriously imprecise, and Wall Street banks including Goldman Sachs said at the time that the CBO’s estimate was much too low, suggesting that the economy could absorb more federal spending than Summers thought.

Likewise, the conclusion by Bianchi and co-author Leonard Melosi of the Chicago Fed that the rescue plan accounts for roughly half of the added inflation assumed that Americans have lost confidence in the government’s willingness to repay the debt incurred during the pandemic and thus anticipate that inflation will stay high.

But so far, there is no sign of that concern. Bond investors expect prices to rise at an average annual rate of less than 2.5 percent over the next decade, according to one financial market gauge.

Some economists agree with the White House that the jobs and growth gained more than offset any effect on prices. Mark Zandi, chief economist for Moody’s Analytics, said the rescue plan initially had provided some “good inflation” after years in which the Fed struggled to get the economy moving fast enough to reach its 2 percent target for price stability.

Subsequent “bad inflation” came from coronavirus-related disruptions and commodity price shocks associated with Russia’s invasion of Ukraine, Zandi added.

Yet a pair of recent studies from the San Francisco Fed suggest a bigger role for the rescue plan. Inflation in the United States raced ahead of price measures in other advanced economies in early 2021 as rescue plan funds began flowing, according to a March study by economists Oscar Jorda, Celeste Liu, Fernanda Nechio and Fabian Rivera-Reyes, which said higher government spending lifted inflation rates by three percentage points.

Unusually high demand for goods and services played a large role in driving prices higher starting in March as the rescue plan cash began to be distributed, according to Adam Shapiro, another economist with the San Francisco Fed.

“The surge in inflation in March 2021 was mainly due to the increase in demand-driven factors. During this period the economy began to reopen from pandemic-related public health policies, and the American Rescue Plan enacted in March 2021 further stimulated demand factors,” Shapiro concluded in a June study.

***

From the start of the pandemic, the United States responded with overwhelming financial firepower. Congress approved the $2.2 trillion Cares Act before the end of March 2020, as the economy was shutting down and millions of Americans were losing their jobs.

During the presidential campaign, as the economy struggled to heal, Biden aides discussed with the former vice president the need to generate economic stimulus plans alongside his signature Build Back Better investment program, according to a senior White House official who spoke on the condition of anonymity to discuss internal deliberations.

Several key members of the Biden team – including the then-candidate – had served in the Obama administration, which was criticized following the 2008 financial crisis for presiding over the weakest economic recovery in the postwar era.

Despite the worst economic crisis since the Great Depression, Obama in 2009 kept his stimulus request below $1 trillion. By 2010, he was discussing potential cuts in government spending under pressure from congressional Republicans, even as the jobless rate hovered near 10 percent.

Ultimately, it took more than six years for the United States to recover the jobs that had been lost in the recession.

Along with Biden himself, Obama administration veterans Cecilia Rouse and Jared Bernstein of the Council of Economic Advisers; Brian Deese, director of the National Economic Council; and Sperling concluded that it would be better to overshoot on economic repairs than undershoot.

Along with the third round of stimulus checks, the rescue plan funded an additional $300 weekly unemployment benefit, an expanded child tax credit and aid to state and local governments.

“When you are coming out of a deep recession, you need to have an insurance policy against unexpected economic hits, because if you get stuck before you get all the way back, the pain can be long term and scarring for millions and millions of workers,” Sperling said. “That is what happened after the Great Recession. Having a stronger and longer-lasting rescue plan was an important lesson learned.”

***

Eighty days before Biden signed the rescue plan into law, Congress in December 2020 approved a $900 billion coronavirus relief measure, which included $600 stimulus checks, rental assistance, help for small businesses and funding for vaccines and testing.

Democrats, who had pushed for a larger package, vowed to pass additional relief after Biden’s inauguration.

On Jan. 5, Democratic candidates in Georgia won both U.S. Senate seats – and control of the chamber – in runoff elections after promising another round of stimulus checks.

Three days later, while the country was still reeling from the attack on the U.S. Capitol, a government report showed that the economy had lost 140,000 jobs in December. Without more government funding, the jobless rate would be weaker than pre-pandemic forecasts until 2024, leaving millions without work for years, the White House warned.

More than 3,300 Americans were dying each day as the omicron variant spread across the country, leaving the nation unsettled about the days ahead.

These signs of fresh economic weakness cemented the political imperative to spend more on coronavirus relief.

Still, voices on both sides of the aisle urged restraint. Summers, a Democrat and former treasury secretary, published an op-ed in The Washington Post complaining that the president’s proposed $1.9 trillion stimulus was three times what was needed to fill the hole in the economy.

That same day, Michael Strain, a former Fed economist now with the right-of-center American Enterprise Institute, made a similar case in congressional testimony, zeroing in on plans for new stimulus checks, enhanced unemployment payments and aid to state and local governments.

All were too big, he said, adding that a $750 billion alternative would be more appropriate.

***

Americans received stimulus payments worth more than $242 billion in the first six days after Biden signed the rescue plan into law, a tremendous infusion of cash. Billions of dollars more went out at weekly intervals over the next month.

Though it wasn’t clear at the time, the checks landed on an economy that was already growing at an annual rate of more than 6 percent.

The first burst of rescue plan payments coincided with a surge in spending on new and used cars, according to Commerce Department data. Many new car models were in short supply because of a shortage of computer chips. Many consumers who might have preferred a new car ended up buying a used one.

Consumers flush with rescue plan cash encountered a market that was millions of cars short. Prices for used cars rose in April by 10 percent, the largest one-month gain since the government began keeping track in 1953, and then jumped by an additional 8 percent in May.

Rescue plan money wasn’t the only factor driving sales. Consumers also had received delayed tax refunds and were drawn to car lots by good weather and sales incentives. Many who had delayed purchases during the first year of the pandemic finally felt free to shop as vaccines became more widely available.

“The increase that we’re seeing is beyond the stimulus,” Bill Nash, chief executive for CarMax, told investors in April 2021.

Other retailers, including Walmart and Home Depot, said stimulus checks had helped their sales, too.

In many corners of the economy, employment rose alongside prices.

Used cars and trucks cost 37 percent more at the end of 2021 than they had at the beginning of the year. Yet even as shoppers grumbled, job seekers celebrated. Used vehicle retailer Carvana doubled its workforce to 21,000 people over the course of the year, according to securities filings.

Still, White House officials were sensitive to criticism that the stimulus payments were not targeted to those with the greatest need. Married couples with incomes up to $150,000 – or individuals making $75,000 – were generally eligible for the full $1,400 benefit.

More than $94 billion was paid to Americans with household incomes above the national median, according to Treasury Department statistics.

“It could have been distributed a little better,” said Lisa Franzese, 54, a payment accounts coordinator in Lakeland, Fla., who said she remained employed throughout the pandemic. “I understand they didn’t have time to drill down to determine who needed it most. But not everybody needed it. It could have been held back from people like me and given to people who had more dire needs.”

Yet at the time, most economists saw little risk. In June 2021, when the University of Chicago Booth School of Business surveyed economists, just 26 percent agreed that U.S. spending and monetary policies posed “a serious risk of prolonged higher inflation.”

***

Republicans over the past year have pointed to Biden’s coronavirus spending as a principal source of the worst inflation since the Carter administration.

As inflation topped 9 percent in June, GOP prospects for grabbing the reins of Congress rested on attacking the president for losing control of consumer prices. That big number, though, was pushed by a surge in energy prices related to the war in Ukraine.

Erica Miller, 26, an attorney in Lincoln County, N.C., said the rescue plan “absolutely” helped fuel inflation.

“I don’t think it was the best call,” she said. “They say we’ve recovered from the recession quicker, but I’m not sure. In the small town I live in, they’re still hurting for workers. Everybody’s very frustrated. Lots of businesses need workers, but nobody wants to work.”

In July, 32 percent of those surveyed by the Pew Research Center said that government spending to address the economic impact of the coronavirus had contributed “a lot” to inflation and 38 percent said it had added “some” to rising prices.

But larger numbers blamed corporate profiteering, supply chain woes and Russia’s invasion of Ukraine. Miller said she recognizes that inflation was a “perfect terrible storm” made up of many factors.

Any assessment of the rescue plan’s inflationary fallout must recognize the program’s labor market dividends. In August, total employment for the first time exceeded its pre-pandemic peak, marking a 30-month rebound that was more than twice as fast as the recovery after the Great Recession in 2008.

Speaking in the Eisenhower Executive Office Building in September, the president hailed signs of continued jobs growth and called them evidence that his plan was working.

“Thanks to the American Rescue Plan, we have come a long way,” Biden said.