Was it a minor contributor or a major factor in the US’s inflation woes?
With President Joe Biden’s legislative agenda stalled in Congress, the American Rescue Plan — the $1.9 trillion stimulus bill Democrats passed in March 2021 — may stand as his biggest achievement.
But did it contribute to the country’s current inflationary mess?
The massive spending law, which included $1,400 checks for each person in a family, generous expansions to unemployment insurance and child tax credit benefits, and hundreds of billions in aid to state and local governments, was intended to help people in need and stimulate economic demand, and it did.
Some economists argue, though, that all this came at the cost of making inflation worse. New Consumer Price Index numbers released Wednesday showed prices up 8.3 percent compared to one year before. And “core inflation,” which excludes volatile energy and food prices, rose 0.6 percent in just one month.
Countries around the world are struggling with inflation due to pandemic disruptions, but the Biden stimulus made the US’s inflation problem more severe, to at least some extent. “I think we can say with certainty that we would have less inflation and fewer problems that we need to solve right now if the American Rescue Plan had been optimally sized,” said Wendy Edelberg, a senior fellow in economic studies at the Brookings Institution.
Inflation has brought with it two big problems. The first is already evident: Because most Americans’ wages haven’t risen enough to keep up with it, real (inflation-adjusted) wages have been declining at the highest rate in four decades.
The second problem is, if inflation remains so persistent, what reining it in could entail. The Federal Reserve has started raising interest rates in an effort to cool down the economy. They’re trying to do so gingerly, aiming for a “soft landing.” But if demand and investment end up plummeting in response, the US could face a painful recession.
What the future holds is uncertain, but to understand how we got here, it’s worth reassessing the past. The American Rescue Plan was drafted with good intentions, but it caused real problems.
The US had significantly worse “core” inflation than comparable economies
It’s important to understand the broader context. Inflation has been happening across the world, caused by pandemic-related disruptions, and exacerbated this year by Russia’s invasion of Ukraine and China’s Covid-19 lockdowns. Even before the American Rescue Plan passed, “the seeds for a high-inflation environment were already planted,” said Marc Goldwein of the Committee for a Responsible Federal Budget.
But regarding the exact amount of inflation, the US stands out. And it started to stand out shortly after President Biden took office.
From 2021 onward, what’s known as “core inflation” has been significantly higher in the US than in other wealthy countries. (Core inflation is a common metric that excludes food and energy prices, which tend to be volatile, to try to get a better sense of general price levels and inflation in an economy.)
A recent article published by the Federal Reserve Bank of San Francisco makes this point. The authors — Òscar Jordà, Celeste Liu, Fernanda Nechio, and Fabián Rivera-Reyes — compare core inflation in the US to the average of eight wealthy countries (the United Kingdom, France, Germany, Canada, the Netherlands, Norway, Sweden, and Finland). Before 2021, these and the US had similar inflation levels. Then the US’s shot up.
The authors don’t mince words about why they think that is, writing: “Estimates suggest that fiscal support measures designed to counteract the severity of the pandemic’s economic effect may have contributed to this divergence by raising inflation about 3 percentage points by the end of 2021.”
That is: The US did a lot more stimulus than these other countries, and now it’s seeing a lot more core inflation. And the stimulus that most stands out is Biden’s $1.9 trillion American Rescue Plan — because it was enacted after more than $3 trillion had already been spent to stimulate the economy under Trump, with one big chunk of that being approved just three months prior.
“We put gasoline on the fire. That’s basically what the ARP did. It was almost written as if we didn’t just pass a trillion-dollar stimulus in December,” said Goldwein.
This core inflation divergence between the US and comparable countries continued into 2022, as Jason Furman, an economics professor at the Harvard Kennedy School and former chair of the Council of Economic Advisers under President Barack Obama, pointed out on Twitter (though it’s also worth noting Europe has been hit by rising energy and food costs after the Ukraine invasion).
U.S. inflation remains *much* higher than euro area inflation. This is the 12-month change in core HICP, a somewhat comparable measure for the two economies.
The US has consistently been ~4pp higher than Europe. That is a HUGE difference. pic.twitter.com/pboWfRluRR
— Jason Furman (@jasonfurman) April 12, 2022
There’s a range of opinion among economists on how much of the US’s higher inflation over 2021 (a 7 percentage point increase including energy and food prices, and a 5.5 percentage point increase excluding them) can be attributed to the American Rescue Plan. Michael Strain of the right-leaning American Enterprise Institute has estimated the law added 3 percentage points. Dean Baker of the left-leaning Center for Economic and Policy Research, though, put that number at 1-2 percentage points.
Some economists with lower-end estimates still argue that it’s a mistake to put too much blame on the American Rescue Plan, which in their view was just a minor contributor to inflation. The White House shares this view. A senior White House official, speaking on condition of anonymity, said there were other potential explanations for differing core inflation rates in the US and Europe, and that arguments blaming Biden’s stimulus were merely correlational.
The US also stands out from other countries in a more favorable way: It had a quicker and stronger economic recovery in 2021. That indeed seems to be partly because of the Biden stimulus spending.
International comparisons, though, suggest the US would have bounced back without the American Rescue Plan, though more slowly. “I think we would have had a slower recovery, we would’ve had more suffering along the way,” Furman said in an interview. “But pretty much everyone, including countries that did basically nothing, has recovered. And the side effects [in the US] have been quite problematic.”
And if temporary help has worsened to a longer-term inflation problem, that isn’t great. Wages, when adjusted for inflation, have seen their most dramatic yearly drop in 40 years. A major fear is that inflation will become (or is already becoming) a self-fulfilling prophecy, as consumers and producers come to expect it and act accordingly. Then a different sort of economic pain could lie ahead as the Fed tries to get inflation under control. “Ultimately, if you have a situation where wages aren’t keeping up with prices and the risk of recession is really quite high, that’s not a good situation to be in,” Strain said.
The criticisms of the American Rescue Plan
The case that the American Rescue Plan contributed to inflation has three parts: its size, its timing, and the details of its spending.
First, the size: $1.9 trillion. Many economic analysts at the time argued that this was too big. saying their models showed so much new spending (on top of trillions already spent) wasn’t necessary to stimulate the economy, and risked overheating it and causing inflation. “I was on the expansionary side of every fiscal debate of my life up until last year,” said Furman. “But quantities matter. It can’t just be that more is better.”
In early 2021, a group of 10 Republican senators had proposed a $618 billion stimulus as a counteroffer to Biden’s. But Democrats, haunted by what they believed to have been policy mistakes from the Obama administration, rejected this, and decided going as big as they could was preferable to possibly spending too little.
“The sweet spot, I think, might have been a $300-500 billion American Rescue Plan,” said Strain. “That could have given us a lot of the benefits of the ARP without sparking such rapid price growth. The ARP was so big that the kind of marginal dollar went to inflation, not to increased economic output.”
Second was timing: that money was mostly spent quickly (about half was spent last year), rather than spread out over a longer period of time. This sent a lot of money flowing into the economy last year — which was the goal — except supply couldn’t keep up, and prices rose.
Third was composition: what the plan included. Much of the ARP’s spending did quite a lot to help people in need, with child poverty and child hunger falling. But other parts were not well-targeted. $350 billion was allotted to state and local governments under the outdated assumption that they’d be facing budget crises, but by early 2021 it was already clear most states weren’t facing such crises. (The White House official argued that while many states might not have needed the money, cities still did, and that these funds have been spent more slowly, so they probably haven’t contributed to inflation much yet.)
The checks were another issue. Birthed out of a political promise Democrats made to one-up Trump and try to win the Georgia Senate runoffs, the checks totaled about $400 billion in spending, and some of them went to families whose finances were already in fine shape. Giving money to people who don’t need it isn’t necessarily a bad thing in and of itself. But if the consequences are higher inflation and economic woes affecting everyone, well, it is a big deal.
“Had we made the checks smaller and more targeted, and spread out over time. I think we would’ve had less unwelcome inflation and a slower recovery in real activity,” said Edelberg. “That’s probably a trade-off, in retrospect, that would’ve been a good one to take.”
Meanwhile, the plan’s anti-poverty benefits proved to be temporary, when the expanded child tax credit expired at the end of 2021. Democrats had hoped to extend it further in the Build Back Better legislation, but Sen. Joe Manchin (D-WV) effectively killed that bill last December, citing inflation concerns. Manchin was always skeptical about the expanded child tax credit on the merits, but rising inflation surely didn’t help Democrats’ case for further big spending.
Good intentions don’t always make good policies
High inflation is now here, and the worse and more persistent inflation is, the more likely it is that the Fed will raise rates to get it under control, and cause a recession.
It’s true that the American Rescue Plan wasn’t the primary cause of today’s inflation. But if inflation was always going to be a problem, then it’s important to avoid policies that could make it a much worse problem.
In retrospect, it seems that Democrats simply didn’t take this seriously enough back in early 2021. They wrongly concluded that a stimulus far in excess of what models said was necessary was the less risky option. They thought they were still in the “money printer go brrr” era, where there was less pressure to be judicious about where that money was going — so instead of targeting help to those who needed it, they sent hundreds of billions of dollars to well-off Americans and states doing just fine, for political reasons.
Now, Democrats had many good intentions in drafting the American Rescue Plan — they wanted to help people and avert economic pain. And they had some successes, like low unemployment and strong GDP growth. But wages haven’t kept up with prices. And if this results in significantly worse economic problems in 2022, 2023, and 2024, not to mention electoral consequences for Democrats, it’s unclear whether it would have been worth it.
“We need to see whether we can really achieve a soft landing without bringing about a recession that involves a lot of pain,” Edelberg said. “Whether this all has a happy ending is still yet to be determined.”