In early March, the US senate passed into law the largest expansionary fiscal package since the 1960s. Biden’s USD$1.9 trillion stimulus was criticised for its ambitious size and scope, with fears that all this extra money would lead to a surge in prices. As a result, inflation has returned as a hot topic of debate.
Weighing in on the conversation, Harvard professor and former Treasury Secretary Lawrence Summers recently went head-to-head against Princeton professor and Nobel-Prize winning economist Paul Krugman to debate the question: ‘Will the Biden stimulus lead to inflation?’. Before we dive into their arguments, we should first understand what the package includes.
Biden’s stimulus package
In stark contrast to Reaganomics of the 80s, which endorsed reduced government spending, Biden focuses on transferring cash to the bottom 2/3rds of households to drive growth through consumption. This may be fitting as the pandemic has disproportionality affected low-income households, with more than 18 million people on unemployment claims in the US compared to a year ago. Biden’s stimulus aims to cast a wide net given the complexity of obtaining data and designing policy to target households affected by the pandemic in specific ways.
The final bill includes $US400 billion in one-off US$1,400 cheque payouts to most Americans, an extension to jobless benefits of US$390 a week for those unemployed by the pandemic, as well as billions in aid to state and local governments. For many in Biden’s administration, a strong fiscal package will help ‘run the economy hot’, boosting employment and wages at the potential expense of above-target inflation.
For: Summers argues the output gap
“While there are enormous uncertainties, there is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability,” – Lawrence Summers
Summers’ main critique of the stimulus is its ‘excessive’ size and what it is directed towards. He highlights CBO forecasts which indicate the planned fiscal spending dwarfs the estimated output gap. The surge in money supply would increase risk of inflation, which he claims has historically led to the Fed raising rates and inducing a recession. He also argues that the opportunity cost of over-spending on households now is less longer-term investments in infrastructure and renewable energy in later years.
Against: In defence of Biden
Krugman, on the other hand, argues in defence of Biden’s stimulus and likens the US situation to other crises. The substantial public spending is framed as emergency relief to tackle the economic fallout of COVID-19, specifically targeting those who became unemployed due to the pandemic.
“When Pearl Harbor gets attacked, you don’t say ‘How big is the output gap?’”– Paul Krugman
Although Krugman acknowledges the one-off cheques paid to most Americans may be unnecessary, he retorts that the popularity of this particular policy is important for the bill to successfully pass Congress. Last but not least, he argues the stimulus won’t overstimulate economy and cause inflation as this extra cash will largely be saved rather than spent.
Savings vs. pent-up demand
Data shows that household savings throughout the pandemic has spiked; US excess savings relative to a non-pandemic scenario was at 6% of GDP by the end of 2020 and estimated to reach 10% in 2021 following Biden’s stimulus. While most excess savings are usually held by capital-owners and wealthier individuals, a large share of Biden’s stimulus will be channelled towards the mid-to-low-income brackets of the American population who have higher marginal propensities to spend.
Does this mean we should subscribe to Summers’ fear of an excessive burst in demand? Not quite. Summers may be right about increasing inflation, but this is a country hit by a severe health and economic shock after decades of disinflationary pressures; we are more likely to see a temporary price increase before support measures are unwound.
Pent-up demand may already be exhausted or will at least be stifled by economic scarring. Historically after a recessionary period in the US, the release of pent-up demand has boosted consumer durables spending as a share of GDP by 0.6 percentage points on average. Therefore, the recent increase of 1.35 percentage points suggests an unsustainable level of consumption. Coupled with the fact that the pandemic will have a lasting influence on consumer behaviour, demand in the service sector and unemployment, we are unlikely to see wild inflationary spending that will force a disruptive move by the Fed.
While it is certainly true that inflation pressures are rising, it has been the more popular view that these concerns are overstated relative to the role of the stimulus in aiding economic recovery. In 2009, Summers himself espoused the notion that the cost of doing too little is greater than the cost of doing too much. This time Krugman is presenting this case back to him. Only time will tell who is right.
 Bendheim Center for Finance. (2021). Will the Biden Stimulus Lead to Inflation? A Conversation with Paul R. Krugman And Lawrence H. Summers. https://bcf.princeton.edu/events/a-conversation-with-paul-krugman-and-lawrence-h-summers/
 Dayen, D. (2021). First 100: Defining Bidenomics. https://prospect.org/first100/defining-bidenomics-fiscal-spending-monetary-policy-running-economy-hot/
 ABC. (2021). US Senate Passes President Joe Biden’s $US1.9 Trillion Covid-19 Bill, But No Change to Minimum Wage. https://www.abc.net.au/news/2021-03-07/us-senate-passes-president-joe-biden-covid-relief-bill/13224422
 Summers, L.H. (2021). My Column on The Stimulus Sparked a Lot of Questions. Here Are My Answers. https://www.washingtonpost.com/opinions/2021/02/07/my-column-stimulus-sparked-lot-questions-here-are-my-answers/
 The Economist. (2021). The World’s Consumers Are Sitting on Piles of Cash. Will They Spend It? https://www.economist.com/finance-and-economics/2021/03/09/the-worlds-consumers-are-sitting-on-piles-of-cash-will-they-spend-it
 Roach, S.S. (2021). The Limits to America’s Pent-Up Demand. https://www.project-syndicate.org/commentary/limits-of-us-consumer-demand-rebound-by-stephen-s-roach-2021-02?barrier=accesspaylog