US | Stimulus may heat up the economy, but won’t burn it
The debate around the economy’s need for Biden’s $1.9tn American Rescue Plan (ARP) is heating up. A few prominent economists recently argued that while relief funding is important and some stimulus is needed, the package could lead to spiraling inflation, financial market instability, and reduced fiscal space for further stimulus. We disagree on all three fronts. Instead, we see strong reasons why the dire outlook and fear of the unknown are overstated.
First, while greater economic growth will lead to the longest inflation stretch above 2% since before the financial crisis, inflation is unlikely to sustainably breach 3%. Weak pre-Covid structural inflation dynamics, lingering demandside shortfalls, a supply-side response to stronger demand, and anchored inflation expectations lead us to believe inflation won’t spiral out of control.
Second, while the US economy will recoup its pre-Covid size in Q2 and real GDP could surpass potential output in H2, we expect several sectors to remain well below their potential for the foreseeable future. The 10 million jobs shortfall is one illustration of the lingering demand gap. Even with our forecast for a gain of 6.6mn jobs in 2021, we don’t foresee significant wage pressures feeding into inflation.
Third, while we acknowledge that higher inflation is a serious risk against which financial markets should hedge, financial instability concerns appear overblown. Higher Treasury yields and moderate downward asset price pressure are realistic expectations, but they don’t equate to instability.
The idea that pushing for a $1.9tn plan reduces fiscal space is also doubtful. The current low cost of debt and the fact that Biden’s proposed Build Back Better plan is geared toward lifting the economy’s supply side should dissipate fears that fiscal space will be a rare commodity in coming months.