How will US fiscal policy affect pressure on prices?

by Elliot Aurissergues, Christophe Blot and Caroline Bozou

The latest inflation figures for the United States
confirm the trends seen over the last few months. In October 2021, consumer
prices rose by 6.2% year-on-year. While rising prices is a global phenomenon, among
the industrialized countries this has been particularly marked in the US. Inflation
in the euro zone over the same period was 4.1%. This level of increase in
inflation has not been seen since the late 1990s, so it is attracting
considerable attention in the US policy debate, not least because it echoes a
controversy that began early in Joe Biden’s mandate over the fiscal stimulus
passed in March 2021. Although inflation is being driven in part by rising energy
prices, the fact remains that tensions have rapidly increased. Excluding energy
and food components, inflation has exceeded 4% since June 2021, suggesting a
risk of overheating for the US economy. While the European macroeconomic
context does not allow us to identify an equivalent risk for the euro zone, the
fact remains that a sustained rise in US inflation could have repercussions for
the zone. Beyond the impact on competitiveness, the dynamics of US inflation
could influence decisions on rate changes and the conduct of monetary policy by
the Federal Reserve and the European Central Bank.

Regardless of the indicator – consumer price index
or consumption deflator – prices have clearly accelerated since March 2021 (see the figure)[1]. The energy component is undoubtedly important,
but it does not fully explain this dynamic, since the latest figures for the
underlying indices, i.e. adjusted for energy and food prices, show a
year-on-year increase of 4.6% for the CPI and 3.6% for the consumption deflator[2]. Note too that this development reflects a
catch-up from 2020, when inflation was particularly moderate in the context of
the pandemic and the sudden halt in activity. Thus, on average over 2020 and
2021, up to October, the consumption deflator has risen by 2.1%, in line with
the target adopted by the Federal Reserve[3]. The recent tensions obviously reflect the
dynamics of the post-lockdown global economic recovery, which the United States
is clearly part of, and which has led to strong pressure on energy prices, but
also on supplies, as evidenced by the supply difficulties for certain goods and
the soaring cost of maritime freight.

Beyond these global factors, there is the question
of an inflationary phenomenon that may be intrinsically linked to US economic
policy. Even before the recent discussions on the 2022 budget vote, the
measures taken to deal with the Covid crisis first by the Trump administration
and then by the Biden administration amount to a grand total of USD 5.2
trillion, representing more than 23 points of GDP for the year 2019. This
spending over 2020 and 2021 represents an unprecedented level of stimulus over the
last forty years. While there was undoubtedly a consensus on the need for the
measures proposed by Biden and approved by Congress in March 2021, their
magnitude nevertheless caused a great deal of debate, as the recovery was
already underway and the economy was already benefiting, as it still is today,
from the fiscal support measures voted in 2020 and from a highly expansionary
monetary policy[4]. Could this expansionary economic policy – both fiscal
and monetary – be causing the economy to overheat, fuelling the return of
inflation, as economists such as Lawrence Summers and Olivier Blanchard fear,
or, on the contrary, is the effect on inflation being overestimated, as other
analyses suggest? We plunge into this debate in an OFCE
Policy Brief,
specifying in particular the conditions that could lead to a sustainable
increase in inflation. The risk will depend on the size of the multipliers
measuring the effect of the stimulus plans on activity and unemployment, the
position of the US economy relative to its potential, and changes in inflation
expectations, all of which are subject to some uncertainty.

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[1] The consumer price index (CPI) is calculated from
a survey of the prices of a basket of average goods consumed by a
representative household. The consumption deflator is derived from the national
accounts and represents the price system that allows the transition from
consumption in value to consumption in volume. See La désinflation importée [Imported
Deflation] in OFCE Review, 2019, No. 162, for more details on the
difference between these two measures of inflation.          

[2] Unadjusted for energy and food prices, the
consumption deflator rose by 4.4%. The data for the deflator refer to the month
of September, while the publication of the consumer price indices is more
rapid, the latest figures published being those for October.

[3] The consumer price deflator is the indicator used
by the Federal Reserve to assess price stability in the United States.

[4] Two other projects were then announced: an
infrastructure investment plan (American Jobs Plan)
and a household package (American Families Plan).
These are not crisis-specific measures, but measures that are supposed to mark
the direction of fiscal policy over the next eight years. These plans are
currently being discussed in Congress as part of the 2022 budget vote.