Biden’s Curious Talking Point: Lower Deficits Offer Inflation Relief
As Americans face the highest inflation in decades, President Biden has said tackling rising costs is a priority for its administration. Lately, he cited one policy in particular as an inflation-fighting tool: reducing the nation’s budget deficit.
“Cutting the deficit is a way to ease inflationary pressures in an economy,” Biden said. this month. “We are reducing federal borrowing and helping to fight inflation.”
The federal budget deficit – the gap between what the government spends and the tax revenue it collects – remains large. But Mr Biden pointed out that he had shrunk by $350 billion in his first year in office and was expected to drop more than $1 trillion by October, the end of this fiscal year. federal.
Rather than stemming from recent budget actions by his administration or Congress, the deficit reduction largely reflects increased tax revenues resulting from strong economic growth and the end of pandemic-era emergency programs. , such as the extension of unemployment insurance. And for many pundits, that — plus the reality that deficits have a complicated relationship with inflation — makes the fiscal gap a surprising talking point.
“It’s probably not something they should take credit for,” Dan White, director of government advice and fiscal policy research at Moody’s Analytics, said of the government’s focus. Biden team on deficit reduction. Expiring programs “doesn’t make it worse,” he said.
The Biden administration’s March 2021 spending plan helped the economic rebound, but it also meant the deficit fell less than it would have last year. In fact, the $1.9 trillion relief plan probably added to inflationbecause it injected money into the economy as the job market began to recover and businesses reopened.
But the White House explained its new emphasis on deficit reduction and fiscal moderation in terms of timing. Administration officials say in March 2021 the world was uncertain, vaccines were only just beginning to roll out, and spending heavily on support programs was an insurance policy. Now, with the labor market booming and consumer demand still high, the administration says it wants to avoid increasing spending in a way that could further fuel inflation.
“Supply chains have created challenges in ramping up production as quickly as we could sustain demand,” said Heather Boushey, a member of the White House Council of Economic Advisers. “The point he’s trying to make is that the plan, going forward, is responsible and not about increasing demand.”
Moody’s Analytics estimates that inflation will be about one percentage point lower this year than it would be if the government had continued to spend at last year’s level.
But few, if any, expected these programs to continue. And while it is possible to make a rough estimate of how much fiscal support easing is contributing to the inflation picture, as Moody’s has done, a range of economists have said it is difficult to know precisely how much this matters for inflation.
Understanding inflation and its impact on you
The link between budget deficits and inflation is also more complex than Mr. Biden’s statements suggest.
Deficits, which are financed by public borrowing, are not inherently inflationary: whether they raise prices depends on the economic environment as well as the nature of the spending or reduction in income that has created the budget deficit.
Policies that reduce the deficit could be inflationary, for example. A large, widely distributed stimulus that gives direct cash assistance to low- and middle-income households could be more than offset in a budget by revenues from large tax increases on the wealthy. But transferring much of that money to people who can spend it quickly could cause demand to outstrip supply, leading to inflation. Alternatively, spending that would widen deficits – such as debt-financed investments in energy infrastructure – could reduce inflation over time if the program improves efficiency, increases capacity or makes production cheaper.
“I’m going to fall back on the typical economist answer and say, it depends,” said Andrew Patterson, senior international economist at Vanguard.
The last time the federal government had a budget surplus was in 2001. Since 1970, there have only been four years in which the US government has taxed more than it has spent. During this period, there were periods of high and low inflation.
“There is no simplistic link between deficit and inflation – you need to look at both the demand side and the supply side of the economy,” said Glenn Hubbard, professor of finance and economics at the University of Columbia, which ran the Council of Economic Advisers. under President George W. Bush. The existence or absence of high inflation has more to do with imbalances in the real economy than with complex fiscal calculations. “If aggregate demand is growing much faster than aggregate supply, you will see inflation,” he said.
To complicate matters in the current situation, the stimulus measures of the past two years continue to ripple through the economy because consumers have accumulated reserves of savings which they are spending and because state and local governments continue to use untapped relief funds.
And stimulus-fueled demand is far from the only reason prices are rising. Over the past year, due to factory closures and overloaded public transport routes, companies have struggled to increase supply to meet booming demand. Shortages of cars, sofas, building materials and raw components have helped drive up costs.
Recent global developments are aggravating the situation. The Chinese government’s latest lockdowns to contain the coronavirus threaten to disrupt factory production and shipping, while the war in Ukraine has caused fuel and food prices to rise.
Employers are also raising wages as they scramble to hire in a boiling labor market, and this increase in labor costs is prompting some companies to raise prices to protect their profit levels. Some companies even increase their profits, having discovered that they can charge more in times of high demand.
The demand drag due to the disappearance of pandemic relief does not appear to have been large enough to substantially offset these other forces. To date, price increases for a range of goods and services have generally accelerated.
What is Inflation? Inflation is a loss of purchasing power over time, which means your dollar won’t go as far tomorrow as it did today. It is usually expressed as the annual change in prices of common goods and services such as food, furniture, clothing, transport and toys.
Consumer prices rose 8.3% in the year to April 2022, just slightly below a March high that was the fastest rate of increase since 1981. a sign price pressures remain strong.
What happens next with inflation will likely depend on the Federal Reserve’s response. The central bank is raising interest rates to make borrowing more expensive, a move that could help supply catch up with aggregate demand in the economy, helping to moderate price increases.
But this process is likely to be unpleasant and could disrupt markets, drive up unemployment and even trigger a recession.
Given this grim backdrop, the White House – while acknowledging that the Fed is primarily responsible for managing inflation – also stressed that it was doing what it could to help Americans struggling to pay the groceries, housing and transportation.
The administration has put in place some specific price reduction measures, including the release of oil from the Strategic Petroleum Reserve in an effort to reduce the cost of gas and work to improve the national supply of semiconductors to mitigate a shortage. But many of these efforts are either short-term moves or changes that will take a long time to bring significant relief.
“They seem determined to at least look like they can find ways to fight inflation,” said Sarah Binder, a political scientist at George Washington University. Still, she said, she found the administration’s new focus on the deficit unusual.
“In some ways, it’s a little surprising: Most voters don’t pay that much attention to the deficit,” Binder said. Gallup Poll shows that 17% of Americans say inflation is the biggest problem facing the country, while 1% cite the deficit.
Either way, the government may struggle to reduce the deficit in the next few years. Bipartisan deals to substantially raise taxes or cut some form of spending have proven elusive. Pandemic spending programs are largely outdated, so their expiry will not have as much impact on the deficit in the future.
The Congressional Budget Office expects the deficit to start rising again in 2025 in dollar terms, and it could rise further as a percentage of gross domestic product in 2026.
Recently the President possesses promoted another idea to fight inflation: “Make sure the wealthiest companies pay their fair share.” Since his 2020 campaign, he has pushed to raise the corporate tax rate to 28% from 21%.
Some researchers argue that while such changes could help dampen inflation at the margin, changes in taxation and spending should not be the first line of defense against a sudden rise in prices.
“Fiscal policy shouldn’t be your primary inflation-fighting tool,” said Louise Sheiner, policy director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution. “On inflation, it’s mostly at the Fed.”