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Inflation debate heats up over Biden relief bill
President Biden is making some economists worried with his high-stakes gamble that a nearly $2 trillion COVID-19 relief package will give the economy a major boost without pushing up inflation into dangerous territory.
The intensifying debate comes as the Senate is poised to pass the measure as early as this week, sending it back to the House for possible final passage next week. With the finish line in sight, some economists are sounding the alarm, particularly after financial markets signaled unease with the possibility of inflation on the horizon.
"To say he's taking a risk would be an understatement," said Desmond Lachman, an economist at the right-leaning American Enterprise Institute and former deputy director at the International Monetary Fund.
For Biden, the relief package and its key components - stimulus checks, increases to child and earned income tax credits, emergency unemployment benefits - could set the tone for his presidency.
A well-calibrated economic response could also help bring down unemployment, speed the recovery and set the stage for Democrats to head into the 2022 midterm elections with powerful economic tailwinds.
But overshooting and sparking a significant spike in inflation could lead to major economic and political repercussions that might require intervention by the Federal Reserve.
"If inflation gets out of control, the Fed has to step on the brakes and start jacking up the interest rates, and that normally produces a recession," said Lachman.
Like most economic shocks, a sharp rise in consumer prices would hit poor households the hardest by reducing the purchasing power of their already-low incomes.
Republicans, who are almost universally expected to vote against the relief package, would be well-armed in their efforts to disparage the legislation heading into the midterms. That would put the White House on the defensive for a measure that is already expected to be followed by a heavy messaging campaign after Biden signs it into law.
"He's going to have a great economy in the second half of this year, but then he runs the risk of a recession as he enters the midterms," said Lachman, who is not the first to sound the inflation alarm.
Larry Summers, who served as Treasury secretary during the Clinton administration and then as a top economic adviser to former President Obama, made waves last month by warning that Biden's stimulus package could overheat the economy, leading to higher prices.
Most Democrats, however, point out that similar warnings in the past have led to small fiscal responses that ended up restraining growth, while unprecedented moves by Congress and the Fed failed to even bring inflation close to its target level of 2 percent.
Biden, in particular, says he does not want to repeat the mistakes made in 2009 during the Obama administration, when a stimulus package in response to the Great Recession was around $800 billion amid similar inflation warnings.
"It wasn't quite big enough. It stemmed the crisis, but the recovery could have been faster and even bigger," Biden said last month.
Top economists, including Federal Reserve Chairman Jerome Powell and Treasury Secretary Janet Yellen, say that inflation is a solvable issue.
"As Treasury secretary, I have to worry about all of the risks to the economy, and the most important risk is that we leave workers and communities scarred by the pandemic and the economic toll that it's taken, that we don't do enough to address the pandemic," Yellen said last month.
"I've spent many years studying inflation and worrying about inflation, and I can tell you, we have the tools to deal with that risk if it materializes," she added.
But recent activity in the bond market has exposed some concerns.
Data from the St. Louis Federal Reserve showed inflation expectations have risen to their highest level in 10 years. Bond yields spiked last week to more than 1.6 percent, a major move from the sub-1 percent level of just a few months ago.
Stock markets tumbled and have stayed on edge as bond yields remain elevated.
"It's telling you that the bond vigilantes are getting back," said Lachman, referring to bond traders who sell off bonds over inflationary concerns, lowering the price and raising the yields.
Sen. Pat Toomey (R-Pa.) said the COVID-19 relief bill could exacerbate things.
"The result could be inflationary pressures of a kind we haven't seen in a generation," he said at a Tuesday hearing.
Higher expectations of inflation could lead to premature increases in interest rates, which could hamper economic growth. In the late 1970s and early 1980s, the Fed consistently hiked interest rates to break a cycle of persistent inflation, causing serious economic pain in the process.
But plenty of people think the threat of a big, sustained spike in inflation is overblown this time around.
Fed Governor Lael Brainard on Tuesday said that while bursts of inflation were likely, it would not be the kind of prolonged inflation that led to problems in the past.
"Transitory inflation pressures are possible if there is a surge in demand that outstrips supply in certain sectors when the economy opens up fully," she said.
Ryan Severino, chief economist at real estate company JLL, agrees, saying inflation could reach 2.5 percent in the coming years, and even briefly spike above that level, without setting off a five-alarm fire at the Fed.
"It's not the same economy as it was 50 years ago. There have been serious structural changes that make the economy operate differently," he said.
The combination of globalization, demographic changes and the impact of technology on the economy all point to lower price increases than in the past, he noted.
If inflation only rises modestly, Biden's gamble could pay off, leaving him with a towering economy and removing a target for Republicans.
"I think inflation is almost certainly going up from where it was in the downturn, and there's a good chance that it'll run higher than what we've seen in the last 10-12 years," said Severino.
"But people are making an argument that we're headed toward the kind of sustained inflation we saw in the '70s, and that seems to be a much lower probability."