Focusing on the demand side, even most pessimists – myself included – missed a pressing problem. Supply chain bottlenecks have led to shortages of many goods, a crisis exacerbated by Americans’ reluctance to return to work. The shortage of workers has also hurt the service sector. Many restaurants, for example, are still closed because they cannot find workers. Both raise prices.
Now, between government payments and underspending during the pandemic, American consumers are holding an estimated $2.3 trillion more in their bank accounts than the pandemic trend predicted. As they emerge from isolation, Americans are eager to spend on everything from deferred vacations to clothing. But the collapse of the supply chain has turned simply spending money into a challenge.
For Democrats, recent disappointing election results and the current legislative crisis offer a dose of cold reality. The administration wanted to claim a big win in politics before the 2022 midterm elections. But inflation fears are high on voters’ minds.
So the administration must come to terms with voters about the impact of spending plans on inflation. “Building back better” can only be considered “paid for” if one adopts budget gimmicks, such as assuming that some of the most important initiatives will be allowed to finish in just a few years. The result: a spending-sustaining package while tax revenue only arrives over a decade. The Committee on Responsible Federal Budget estimates that the plan will likely add $800 billion or more to the deficit over the next five years, exacerbating inflationary pressures.
Mr. Biden also insists that the much-lauded infrastructure bill he just signed has been paid in full – but it isn’t. In fact, the infrastructure figures show $550 billion in new spending and just $173 billion in additional compensation.
Of course, some of the responsibility for overstimulation lies with the Federal Reserve, which correctly responded to the onset of the pandemic by cutting interest rates and sweeping money into the financial system. Lately, the Fed has been too slow to scale back its debt-buying program, sending more money to chase those few commodities. Until recently, Federal Reserve officials have been echoing the White House’s position on “transient” inflation.
For the Fed, tackling inflation will mean raising interest rates, perhaps sooner than it thinks necessary. The Fed is targeting an average annual inflation of 2 percent. So if the pace of price hikes stops well above this level, the central bank will need to raise interest rates to address the problem. While the Fed believes that won’t happen until late next year, the bond market believes interest rates will rise by the middle of the year.