Should the U.S. brace itself for an inflationary spiral?

This article was originally published by El American: elamerican.com/should-the-u-s-brace-itself-for-an-inflationary-spiral/

Inflation has been hidden in developed economies for the last three decades, but after Joe Biden announced the $1.9 trillion fiscal expansion plan, along with the 2020 massive increase in public expenditure due to the pandemic, renewed fears of an inflationary spiral have arisen in the U.S. and around the world.

Many have suggested that if unemployment returns to previous low levels, this could lead to unseen increases in consumption and an overheating of economic activity, which could lead to a marked increase in prices. However, it is not yet clear if we are heading for an inflationary spiral. Should we worry about it?  

Low unemployment is not a reason strong enough to conclude that we should expect extremely high unemployment in the future. From 2017 up to 2019 unemployment levels were below 4%, but inflation didn’t go over 2.5%. That was definitely not an inflationary spiral. In the first months of 2021, and after the pandemic-related shutdowns, inflation just reached 1.6%. Will this be much higher in the future or will its increase mildly? 

The most probable outcome is that inflation will be high in 2021 due to higher consumption of goods and services, both domestic and international, and higher business confidence levels, which will bring attached higher investment. Many citizens haven’t been able yet to spend the checks they were given out by the government in 2020, so they are now desperate to do so. This postponed consumption, if concentrated in a few months, could definitely result in higher future prices. We still need to wait and see the pace of economic recovery and consumption levels to make any firm judgments about its effect on prices. 

The IMF forecasts that American public expenditure programs could contribute to lower unemployment levels down to 3.6% by 2023, and increase inflation up to 2.4%, which can’t be considered as an inflationary spiral. However, if renewed consumption concentrates in a short time span, inflation could definitely be higher than expected at the moment. 

Should we expect 1960s style inflation? It is somewhat misleading to compare the actual situation with that of the Vietnam War when military expenditure caused inflation to rise from 2% up to 6%. At the time, expansionary fiscal policy prolonged fiscal stimulus over a larger span of time, which is not the case now, or, at least, is not what has been announced. Biden’s plan is intended to be a one-off shock, but it still remains unclear how it will be executed. 

It is true that economic recovery and low unemployment can lead to higher inflation, but we can’t omit that technological development and its implementation following the pandemic can help to increase labour productivity growth and incentives for worker’s training and reskilling. This higher productivity could help to compensate higher inflation by pushing down prices in certain sectors. 

The most likely outcome that over the following year or years we should expect higher inflation levels due to lower unemployment, higher consumption levels, and the fiscal stimulus program. However, higher taxes could erode some of the increase in income levels and prevent certain investment operations, which could moderate the increase in prices and slow down the overheating of the economy, at least in the short run. This depends on how and when both, fiscal stimulus and higher taxes, are implemented. We should bear in mind that higher taxes won’t be a one-time policy, but a permanent one, having effects in the long run on the U.S. economy. 

So, should we all brace for high inflation? Yes, and probably at higher levels than over the past few years. But can we expect an inflationary spiral? Probably not, and definitely not in 1960s style.