Liberal economists got the memo: Build Back Better couldn't possibly worsen inflation

Democrats are on a mission to dispel any notion that massive new government spending in their Build Back Better (BBB) bill will let roaring inflation out of its decades-old cage. And right on que, liberal economist and New York Times columnist Paul Krugman weighs in: “History Says Don’t Panic About Inflation." 

Actually, history doesn’t say that, just Krugman’s headline.

It’s a hard sell, though. Krugman makes his case based on a July 6 article from the White House Council of Economic Advisors entitled, “Historical Parallels to Today’s Inflationary Episode.”

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Note that the Biden White House published this article more than four months ago, when inflation may not have been out of its cage yet but certainly seemed to be on a long leash. Inflation numbers have steadily increased and will likely go even higher.

But with BBB headed to the Senate for mangling, or even rejection, all the big-spenders, including Krugman, are trying to convince those understandably concerned about raging inflation – both senators and the public – that the beast will be back in its cage soon.

Maybe, but there is at least one important point that Krugman and the White House ignore.

The Council’s paper says that since World War II, “there have been six periods in which inflation – as measured by the CPI [Consumer Price Index] – was 5 percent or higher.” The Council and Krugman both argue the period most closely resembling today’s inflation was the one immediately following the war, 1946-48.

And it’s easy to see why. Rationing and price controls during the war constrained consumption, so pent-up demand was high at the war’s end — just as pent-up demand has been high coming out of the pandemic.

But supplies were limited after the war because manufacturers were transitioning away from war-time products to making products for consumers — similar to the way supply chain problems are limiting supplies now.

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“But,” Krugman informs us, “the inflation didn’t last.” Inflation plunged in 1948, and by 1949 had turned into deflation, where prices were falling. “[T]he biggest mistake policymakers made in response to that inflation surge was failing to appreciate its transitory nature.” 

Krugman’s advice: Don’t worry about the price surges you’re seeing. They’re a result of a special set of circumstances coming out of the pandemic, not Biden’s spending spree. The current inflation problem will resolve itself relatively soon, as it did in 1948. 

We should note that some prominent Democratic economists have raised inflation concerns. Former Treasury Secretary Larry Summers has been warning since February, before Biden’s $1.9 trillion American Rescue Plan passed, that the White House was ignoring inflationary pressures. 

Obama administration economist Jason FurmanJason FurmanLiberal economists got the memo: Build Back Better couldn't possibly worsen inflation Biden should signal to the Fed that it's okay to raise rates next year The Hill's Morning Report - Presented by ExxonMobil - Biden hails infrastructure law, talks with China's Xi MORE was blunter in a recent interview with the Associated Press: “They poured kerosene on the fire!”

And yet both have more recently claimed that all the spending in the BBB would add little or nothing to today’s inflationary pressures. 

One difference in Krugman’s then-vs.-now comparison is the “wealth effect,” where people feel much more financially secure and are willing to spend more when assets like their home or stock prices rise. 

A falling stock market can have the opposite effect. The Dow Jones Industrial Average peaked in April 1946 and started heading downward quickly. By the beginning of the recession in November 1948, the Dow had lost a third of its value. 

A steadily declining Dow may have depressed demand for more goods, taking the pressure off inflation.

Today, just the opposite is happening. Stock indexes are creating new highs. And a much larger percentage of the public is investing in the market. Moreover, the personal savings rate hit record highs during the pandemic. The wealth effect is still having an impact, at least for now, and may encourage people to buy more goods, even at the higher prices.

Biden’s Build Back Better bill is a huge and costly political and economic gamble. His big spending isn’t the only cause of inflation, but it has “poured kerosene on the fire,” as Furman said. Now Biden wants to double down on that spending. 

If inflation continues, it could mean an even tougher drubbing for Democrats at the polls next year. Because the only beast more dangerous to political careers than raging inflation is an angry voter.

Merrill Matthews is a resident scholar with the Institute for Policy Innovation in Dallas, Texas. Follow him on Twitter @MerrillMatthews.