That’s what happened earlier this year when inflation started to take off and the president, Congress and the Federal Reserve came under fire for overstimulating the economy in response to the pandemic. We heard it again late last month when the government announced a second quarterly decline in gross domestic product, triggering dire and exaggerated recession predictions from Republicans. And now Democrats in Congress are adopting the same fallacy by passing a set of fanciful climate, tax and health care initiatives marketed as the “Cut Inflation Act of 2022.”
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Although kernels of truth surround all of these criticisms, they derive from a flawed mental model of the economy and how it works. So let’s take a step back and see what’s really going on.
In the spring of 2020, when a global pandemic was about to plunge the world economy into what would have been a bad depression, central banks and governments around the world effectively printed billions of dollars out of thin air to prevent businesses from closing and laying off. workers while providing households with an income to live on. It worked: after a scary few months of falling stock prices and rising unemployment, financial markets recovered, most businesses continued to operate, and most people who were looking for a job were able to find one.
Unfortunately, as a few of us have warned, governments would continue to provide too much of this fiscal and monetary stimulus for too long.
The charitable explanation, at least in the United States, was that officials were determined not to repeat what they – mistakenly – believed to be the mistake of excessive timidity during the financial crisis and recession of 2008, and that any significant jump in the rate of inflation will be short-lived. An equally plausible explanation is that President Biden and a Democratic Congress were keen “not to let a good crisis go to waste,” and so used it to justify big increases in public spending and investment to achieve justice. economic, social and environmental.
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At the same time, the Federal Reserve (whose chairman, not coincidentally, had just been reappointed) was unwilling to begin reducing its extraordinary money printing lest it burst. the bubble it had created in equities and real values. real estate markets or weaken a labor market that is tight enough to ultimately grant wage increases to low-skilled workers.
What is often forgotten is that even before the pandemic and before all these economic stimulus, the American economy was already significantly unbalanced. For decades, the country had lived well beyond its means, running large and persistent trade and budget deficits made possible by an overvalued dollar, artificially low interest rates and the willingness of trading partners to recycle their surpluses into the American economy. Indeed, these imbalances had persisted for so long that almost everyone had come to believe that they were the new normal and could continue in perpetuity.
Given that pre-pandemic prosperity already depended on large doses of fiscal and monetary stimulus, it should not have been surprising that the injection of trillions of dollars of additional stimulus over the next two years lead to higher prices and wages. Indeed, that was the purpose of these rescue efforts – to prevent a deflationary spiral, to set a floor under household income, to stimulate investment and to support the prices of stocks, bank loans and real estate.
Looking back, it is clear that policy makers ignored the warnings and overdid it. But it is equally true that economic policy is not a science and that the global economy is not a system that can be controlled by a few dials in Washington.
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No less specious, of course, is the Democrats’ claim that inflation will be drastically brought under control by a cut tax and spending bill that closes corporate tax loopholes, expands and expands tax credits. for clean energy, expands health insurance subsidies to the working class, and gives Medicare the power to negotiate the prices of a dozen overpriced drugs.
The Congressional Budget Office estimates that over the next two years the Inflation Reduction Act should change the rate of inflation by less than a tenth of one percent, but it is not sure whether the change is upward or downward.
Even over the next five years, according to the Committee for a Responsible Federal Budget, the package passing through Congress would reduce the federal budget deficit by a paltry $25 billion — a rounding error in a $23 trillion economy. . Whatever the final figure, the measure will do little to reduce an annual federal budget deficit projected operate at the unsustainable rate of 5% of GDP over the next 10 years.
Equally silly is the Republican criticism that the same officials who mistakenly triggered inflation with too much stimulus have now lit the fuse for a long, deep recession by pulling it back.
First of all, most of us do not have an economic antenna sensitive enough to tell the difference between a national economy that produces 1% more goods and services than the previous year and an economy that produces 1% less. The measurement of GDP, gross domestic product, is too imprecise, the difference too small. The partisan hyperventilation about whether or not we are in a recession is more about politics than economics.
More importantly, given that the economy and financial markets are emerging from an intentionally induced sugar spike, the fact that production, employment, home sales and stock prices could decline a little is at the both healthy and necessary. Over the past year, the economy has “created” more than 6 million jobs, an increase of 4%. In an era of restricted immigration and many baby boomer retirements, there simply aren’t enough workers to keep up or even fill the jobs already available. And with government and household spending and borrowing at record highs created by all this stimulus, we shouldn’t be surprised if unemployment rises from its current – and unsustainable – historic level of 3, 5%.
Yes, some workers may lose their jobs as the economy adjusts to a more sustainable level of spending and production, but evidence from employers shows that in most places most should be able to find them another. And to the extent that people are unable to find jobs, it’s not because some officials have set the macroeconomic dials wrong in Washington – it’s because workers are unwilling or unable to move where the jobs are there. Or because educational and labor market institutions are not producing the trained workers that businesses need.
Adjusting to a more stable and sustainable economic equilibrium cannot and will not be painless.
Compared to other things, the value of stocks and real estate will have to fall, and some of the loans used to buy them will be depreciated.
Some workers will need to learn new skills and relocate to find jobs, while employers may need to relocate to find workers and spend more to train them.
Wages paid for low-skilled jobs will have to rise to attract and retain workers, while the inflated incomes of the better-off will have to fall.
Public expenditure will need to be more aligned with public revenue. Households will have to borrow less and save more. Interest rates will have to rise closer to historical levels while the value of the dollar will have to fall, raising the relative price of what we import while reducing the apparent price of what we produce for the rest of the world.
The alternative to returning to equilibrium is to continue to live with the boom and bust cycle of the past 30 years. Such an economy will require ever larger doses of fiscal and monetary stimulus to avoid falling into recession. It will also remain an economy in which the rich get richer and the poor get poorer. It will remain an increasingly dangerously indebted economy vis-à-vis the rest of the world.
In short, a healthy and sustainable economy does not require government officials to constantly and drastically adjust macroeconomic dials in Washington to maintain balance. Rather, it is a market that relies more on the natural self-correcting mechanisms of open, competitive and well-regulated markets.
Steven Pearlstein was a longtime business and economics columnist for The Washington Post and is the author of “moral capitalism,” published by St. Martin’s Press. He is the Robinson Professor of Public Affairs at George Mason University.