Biden's stimulus plan is fueling near-term inflation, a paper from the SF Fed finds

Biden's stimulus plan is fueling near-term inflation, a paper from the SF Fed finds

President Joe Biden's $1.9 trillion US bailout plan is contributing to increased inflation, but it's not expected to overheat the economy, a new San Francisco Federal research paper concludes Reserve.

The package signed in March included stimulus controls, improved unemployment benefits, small business loans, aid for state and local governments and relief for airlines to speed up the economic recovery from the Covid-19 lockdowns.

Seven months later, economists are still debating whether the US economy really needed that much support given the recovery already underway. Inflation is running hot these days, with prices for everything from used cars to gas to bacon soaring .

The SF Fed paper notes that the American Rescue Plan has helped tighten the labor market and will increase the Fed's preferred inflation gauge by 0.3 percentage points this year and 0.2 percentage points in 2022. Its impact will be "negligible" by 2023, the researchers found.

"The estimated impact of the ARP on inflation is meaningful, but still a long way from the severe overheating of the 1960s," the paper concludes.

Job metric hits record high

To gauge the impact of the bills on inflation, the economists looked at a labor market metric known as the vacancy-to-unemployment ratio Firms will be forced to raise wages to attract labor and then raise prices to offset these higher labor costs.

The vacancy rate, defined as the number of job openings relative to the labor force, is at an all-time high today, surpassing levels in the late 1960s, driven in part by a wave of layoffs. A record 4.3 million Americans quit her job in August.

The vacancy-to-unemployment ratio peaked in the 1960s at 1.5 vacancies per unemployed person and bottomed out during the Great Recession that began in late 2007 at just 0.15 vacancies per unemployed person.

Biden's stimulus plan fuels near-term inflation, finds SF Fed paper

In August, that ratio reached 1.25, more than double the historical average of 0.6%, the newspaper said.

Economists estimate that the US bailout plan will have increased the vacancy rate by 0.6 units in 2021 and by almost 0.5 units by the end of 2022.

"This effect is large when you consider that the tightness in the labor market is currently around 1.25 units," the paper says.

How long will inflation stay hot?

However, SF Fed economists have not measured what would have happened to the recovery and inflation if Congress had not passed the stimulus package in early 2021. At that time there were major concerns about the introduction of vaccines and the risk of Covid -19 variants.

It's also important to note that in contrast to the contingency measures in America's bailout plan, Congress is today debating multi-year investments in physical infrastructure, clean energy, child care and social safety net programs. Moody's Analytics said that the longer-term nature of what is now being considered package, together with efforts to boost the labor force, should limit its impact on inflation.

The good news is that SF Fed researchers believe the impact of the stimulus package on inflation and jobs is likely to be temporary, peaking this year and falling thereafter.

Such an outcome depends on two factors: the temporary nature of the increase in government spending and the "stability of longer-term inflation expectations".

"We expect expectations for longer-term inflation to remain strongly anchored, as they have been over the past 20 years," the SF Fed economists wrote.

The risk, however, is that high inflation readings today will lead consumers and businesses to expect higher inflation in the future, creating a self-fulfilling prophecy.

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