If nobody mentions excessive fiscal spending, did it ever happen?
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On Thursday at the ECB's annual forum on central banking, the heads of the Fed, the ECB, the Bank of England and the BIS joined each other on stage for a panel discussion that lasted close to an hour and a half. You can see the entire thing here. I watched it all and, as you might imagine, much of the discussion focussed on inflation.
Despite research from the San Francisco Fed in March concluding that a large portion of the higher inflation in recent months was due to excessive US federal outlays, there was hardly any mention of this by the panellists.
Fed chairman Jerome Powell made a fleeting reference to it when he said that strong consumer balance sheets resulting from covid-related forced saving and fiscal transfers had boosted economic growth and thus inflation. Also, the moderator asked whether there had been a miscalculation as to the impact of the US fiscal stimulus but this was swerved by the heads of the Fed, ECB and BOE. Instead, it was the GM of the BIS who fielded the question, saying simply that traditional tools such as the Phillips Curve had proved unreliable.
That was it. In 85 minutes.
Time and time again, the four central bankers attributed the high inflation to covid- and Ukraine-related supply side issues. Don't get me wrong - I completely understand that these did put and continue to put upward pressure on inflation around the world. But not to confront the demand shock and awe of US president Biden's $1.9 trillion American Rescue Plan, something a number of respected economists have done, seemed strange at best.
The San Francisco Fed paper reckoned that "U.S. income transfers may have contributed to an increase in inflation of about 3 percentage points by the fourth quarter of 2021". Given that US inflation by the end of 2021 was 3.5 percentage points higher than in the same period a year earlier, that's 86%!
I have also written recently about this paper written in 1969 by Norman Bowsher at the St Louis Fed which attributed the high inflation at the end of the 60s to excessive federal outlays from 1965 onwards. Lessons it seems could have been learned.
Finally, I was warning about the potential for higher inflation back in 2018. My view obviously had nothing to do with covid, Ukraine or Biden. With respect to medium term inflation I had observed that the relationship between unemployment and inflation - the Phillips Curve - appeared to still be intact and that with unemployment at low levels there was the scope for inflation to rise. As for longer term inflation, I pointed to the positive relationship in the US between income equality and inflation and that since equality had fallen to very low levels it was probably going to start rising at some point, driving up inflation.
Perhaps excessive US federal outlays did not in fact add fuel to the fire created by covid- and Ukraine-related supply side constraints but the scope for a period of higher inflation was already there. After all, we were overdue one.
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.
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