Biden’s Inflation Globaloney

By David Beckwith

Tuesday, October 27, 2022

 

The president’s excuse is incomplete at best, disingenuous at worst

 

Polls show that inflation is the No. 1 concern for Americans today. Should there be a red wave on Election Day, the current high and sustained level of inflation is likely to be a key reason for the Republican victory.

 

President Biden argues that the inflation crisis is a global phenomenon outside his control. Specifically, the president has been arguing that rising energy costs from the Russia–Ukraine war and some remaining supply-chain disturbances from the pandemic are the main sources of the high inflation. More recently, the president has expanded his argument to blame the “lack of economic growth and sound policy in other countries” (“not so much ours”) for the “worldwide inflation.” 

 

It is true that inflation is soaring across most of the world. The euro area, for example, has seen inflation hit 10 percent. Most observers also agree that the Russia–Ukraine war and other supply-side disturbances have contributed to the surge of inflation across the globe. Adam Shapiro, an economist at the San Francisco Federal Reserve Bank, has estimated that these supply-side sources of inflation account for about half of the U.S. inflation surge from late 2021 through mid 2022. So there is some merit to Biden’s claim that outside forces are affecting the U.S. inflation rate.

 

But this explanation is not the whole story. It ignores the important role played by President Biden’s expansionary fiscal policy and the Federal Reserve’s easy monetary policy in stoking U.S. inflation. It also fails to acknowledge that these stimulative economic policies got exported to other nations and contributed to the global inflation surge.

 

Consider how President Biden’s fiscal policy, particularly his American Rescue Plan (ARP), contributed to inflation. Passed in the first quarter of 2021, it totaled $1.9 trillion in new government expenditures. The U.S. economy at that time, however, needed only about $400 billion to close the hole created by the pandemic recession, according to the Congressional Budget Office. This mismatch created the very inflationary environment that Milton Friedman famously warned about: “too much money chasing too few goods.” President Biden has signed other spending bills into law since then, but the ARP, with its large size and immediate impact in 2021, was the one that created the most inflationary pressure.

 

Larry Summers, a key economic official in the two previous Democratic administrations, warned in early 2021 that the ARP would prove highly inflationary unless “monetary and fiscal policy [could] be rapidly adjusted to address the problem.” Fiscal policy did tighten somewhat as the ARP spending came to an end, but monetary policy remained highly accommodative through 2022. It was not until March of this year that the Fed started raising interest rates from 0 percent, and even then monetary policy remained accommodative by some measures. The combination of a large dollar injection into the economy from the ARP and the Fed’s reluctance to offset it fueled a spending boom that helped create the inflation surge of the past year and a half. This part of our inflation was homegrown.

  

One way to see how expansionary policy fed inflation is to look at total dollar spending in the U.S. economy relative to its pre-pandemic trend. The trend was upward-sloping, reflecting stable growth in the dollar size of the economy. This growth, prior to the pandemic, reflected stable gains in both goods and services as well as low and steady inflation. As long as the U.S. economy stayed on this trend, spending pressures would not be an important source of inflation.

 

During the pandemic recession, total spending collapsed and then quickly recovered. Since the fourth quarter of 2021, total spending has grown above trend, and it is now $1.5 trillion higher than the pre-pandemic growth path. This excess spending, caused by U.S. fiscal and monetary policies, is an important part of the U.S. inflation surge.

 

The euro area’s inflation has been similar in magnitude but is very different in cause. The euro area also had a sharp collapse in total spending, but now it is roughly back on its pre-pandemic trend. Excess spending has not been an important source of the inflation surge in Europe. Energy costs, rising because of the Russia–Ukraine war and other supply disturbances, have driven most of the euro-area inflation. President Biden has the right explanation for the wrong economy.

 

Europe and other regions of the world also have reason to worry that U.S. economic policy is adding to their inflationary pressures. First, the excess U.S. spending has bought up a lot of the goods and services from the global economy. This leaves less for the rest of the world in the short run and thereby raises prices. Second, the dollar’s dominance in the global economy spreads the influence of U.S. monetary policy. The Fed’s large and rapid interest-rate hikes this year, which exceed those in other countries, have made U.S. investments more attractive for foreigners and caused money to flow into the United States. This inflow has, in turn, strengthened the dollar and weakened other currencies. Imports to Europe and other economies are now more expensive. Some of the global inflation, then, is tied to U.S. economic policy, and the fear among foreign officials is that more of it may be on the way.

 

Blaming foreigners for domestic problems is a time-honored political strategy. It is not surprising that Biden has resorted to it, especially when the headline inflation numbers in other countries give his excuses superficial plausibility. But his argument about inflation is incomplete at best and disingenuous at worst. His search for the causes of inflation should begin much closer to home.