One of Sen. Joe Manchin’s main concerns in deciding to pull his support for President Joe Biden’s Build Back Better plan is that it will drive up inflation, which is currently rising at the fastest pace in four decades.
On December 19, 2021, a West Virginia Democrat said in an interview that he cannot support the bill in its current form because he says it will increase consumer prices and the national debt. The decision effectively killed off one of Biden’s top economic priorities.
The Senate was considering a nearly US$2 trillion bill passed by the House that would spend the next decade on health care, education, fighting climate change and more. Senate Majority Leader Chuck Schumer says he still plans to bring it to the floor for a vote.
Munchkin and Republicans have argued the risk that more spending could push inflation even higher.
As an economist, I believe Munchkin’s concerns are misguided. Why here?
Putting $2 Trillion in Context
High inflation is clearly a problem at the moment – the Federal Reserve’s decision to accelerate the withdrawal of economic stimulus signals, as of December 15, 2021.
Inflation, as measured by the annual increase in the Consumer Price Index, stood at 6.8% in November 2021, the most recent figures show. This is the highest level since 1982 – yet still a long way from the double-digit inflation of that time.
The question is, can an increase in extra-large spending accelerate inflation further?
To answer this, it is useful to put the numbers in a context.
The Build Back Better plan passed by the House of Representatives has a price tag of about $2 trillion, to be spent over a 10-year period. If spending were spread out evenly, it would be about $200 billion a year. It is only 3% of how much the government plans to spend in 2021.
Another comparison is with GDP, which is the value of all goods and services produced in a country. US GDP is projected to be $22.3 trillion in 2022. This means that the first year of spending on the bill will be around 0.8% of GDP.
Although it doesn’t seem like much, it’s not insignificant. Goldman Sachs had forecast US economic growth in 2022 at 3.8%. If increased spending is translated into economic activity on a dollar-by-dollar basis, it could drive growth by more than one-fifth.
But what really matters here is how much the bill will cost more than any taxes raised to pay for the program. Higher taxes on the wealthy and corporations that the House version of the bill calls for would reduce economic activity — taking money out of the economy — offsetting some of the impact of spending that would stimulate it.
The Congressional Budget Office estimates the bill would increase the deficit by $150.7 billion over a decade, or about $15 billion annually. Assuming again that this is spread out evenly over 10 years, this would be less than a tenth of 1% of GDP. Even though the elements of the bill are front-loaded, it does not appear that this increase in government debt will contribute much to inflation.
In other words, the proposed spending would have a barely noticeable macroeconomic impact, even if it had an unusually disproportionate impact on the economy.
But it won’t reduce inflation either.
Some proponents of the bill – including the White House and some economists – have moved on. They have argued that the proposed spending package would actually reduce inflation by increasing the economy’s productive capacity – or its maximum potential output.
That seems impossible to me, at least given the current level of inflation. Historical evidence suggests that a more productive economy can grow more quickly with relatively little upward pressure on prices. This is what happened in the US in the 1990s, when the economy grew strongly with little inflation. But it takes time for investments like the bill to translate into gains in productivity and economic growth – meaning many of these effects will be slow to materialize.
And current inflation is potentially a serious problem that reflects supply chain disruptions and stalled demand, challenges that will not be solved by expanding the economy’s productive capacity for five or more years down the road.
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Plus, what’s in the bill will make a huge difference in improving the lives of average Americans, providing more of them with affordable children and health care, and reducing child poverty – areas where America is seriously looking for others. lagging behind rich countries. And it will help America fight the ever-worsening effects of climate change.
While $2 trillion spending would be unlikely to worsen inflation if it becomes law, I believe it could do a lot more materially to address these challenges that America faces. Is.
This is an updated version of an article published on December 16, 2021.