Biden's stimulus plan is fueling short-term inflation, SF Fed paper finds

The package signed into law in March included stimulus checks, enhanced unemployment benefits, small business loans, aid to state and local governments and relief for airlines designed to speed up the economic recovery following Covid-19 shutdowns.

Seven months later, economists are still debating whether the US economy really needed that much support, given that the recovery was already underway. Today, inflation is running hot, with prices spiking on everything from used cars and gasoline to bacon.

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

"The estimated impact of the ARP on inflation is meaningful, but it is still a far cry from the strong overheating of the 1960s," the paper concludes.

Jobs metric sets record high

To gauge the bills impact on inflation, the economists looked at a metric of the jobs market known as the vacancy-to-unemployment ratio. The thinking is that inflation will likely be high when this ratio rises, because businesses will be forced to raise wages to attract workers and then raise prices to offset those higher labor costs.

The vacancy rate, defined as the number of job openings relative to the size of the labor force, is at all-time highs today, surpassing levels of the late 1960s, driven up in part by a wave of worker resignations. A record 4.3 million Americans quit their jobs in August.

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

In August, this ratio hit 1.25, more than twice the historical average of 0.6%, the paper said.

The economists estimate that the American Rescue Plan will have pushed the vacancy-to-unemployment ratio up by 0.6 units in 2021 and by nearly 0.5 by the end of 2022.

"This effect is large, given that labor market tightness currently stands at about 1.25 units," the paper said.

How long will inflation stay hot?

The SF Fed economists did not, however, measure what would have happened to the recovery and inflation if Congress had failed to pass the stimulus package in early 2021. At the time, there were major concerns about the rollout of vaccines and the risk of Covid-19 variants.

It's also important to note that unlike the emergency measures in the American Rescue Plan, Congress today is debating multi-year investments in physical infrastructure, clean energy, childcare and social safety net programs. Moody's Analytics has said the longer-term nature of the package now under consideration, along with efforts to boost the labor force, should limit its impact on inflation.

The good news is that the SF Fed researchers believe the stimulus package's impact on inflation and the jobs market is likely only temporary, peaking this year and falling after that.

Such an outcome hinges on two factors: The temporary nature of the fiscal spending increase and the "stability of longer-run inflation expectations."

"We assume that expectations for longer-run inflation 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 make consumers and businesses expect higher inflation in the future, creating a self-fulfilling prophesy.

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