Two leading economists say that President Joe Biden’s $1.9 trillion COVID-19 stimulus package might overheat the U.S. economy, drive up prices, and force the Federal Reserve to respond by increasing interest rates.
“Much too much is both possible and harmful,” Olivier Blanchard, former chief economist of the International Monetary Fund, said in series of tweets on Feb. 6.
In 2020, “excess saving” by American consumers “was around $1.6 trillion,” he wrote. “As conditions improve, consumers will spend some fraction of it this year. If we say half, that’s $800 billion in additional spending.”
Another $900 billion in “stimulus” was added through the CARES (Coronavirus Aid, Relief, and Economic Security) Act in December 2020. The Biden administration seeks to add another $1.9 trillion to that, which Blanchard calls “too much” but he says could be restrained by new taxes aimed to offset its costs and limit overheating.
“Adding the three numbers above gives: 3.6 trillion or 4 times the upper bound of the output gap,” Blanchard warns.
Assuming an average multiplier of 1, which Blanchard says is on the conservative side, demand will increase in 2021 by about four times the output gap. If this increase in demand can be accommodated, he said, it would result in an output of about 14 percent above potential.
“It would take the unemployment rate very close to zero. This would not be overheating; it would be starting a fire.”
Meanwhile, Larry Summers, a former U.S. Treasury secretary as well as a former chief White House economist, said Feb. 4 in a Washington Post op-ed that Biden’s pandemic relief proposal is so big that it may risk triggering inflation, and “much of the policy discussion has not fully reckoned with the magnitude of what is being debated.”
In response to Summers’s article, Biden economic adviser Jared Bernstein said “Janet Yellen is our Treasury secretary, OK? She knows a little something about inflationary risks.”