Inflation has risen across much of the developed world in the last year, as COVID-19 lockdowns have been lifted and pent-up demand for goods and services has collided with ongoing supply chain snafus.
However, inflation in the United States is currently higher than almost anywhere else. What’s the deal? According to a new paper from four economists at the Federal Reserve Bank of San Francisco, this is because the American government was relatively more generous during the pandemic, borrowing and spending trillions of dollars not only to fund COVID-19 relief efforts, but also to line Americans’ pockets with direct payments that inflated the money supply and overheated the economy.
“Historically, inflation rates in the United States and other developed economies have closely tracked each other,” the economists write in a report released this week. “However, since the first half of 2021, US inflation has outpaced that of other developed countries. Estimates indicate that fiscal support measures intended to mitigate the severity of the pandemic’s economic impact may have contributed to this divergence.”
Inflation in the United States reached a 40-year high of 7.9 percent on an annualised basis in February (data for March will be released by the Bureau of Labor Statistics next week). Meanwhile, similar countries such as France (3.6 percent), Germany (5.1 percent), and the United Kingdom (5.5 percent) have significantly lower inflation, according to data from the Organization for Economic Cooperation and Development (OECD), a consortium of 38 rich-world governments. (Across the OECD, the average annual inflation rate is roughly the same as in the United States, but this is due to the influence of outliers such as Argentina, where prices have risen by more than 52 percent in the past year.)
The global price data for February are not just a snapshot; they are indicative of a concerning trend. In November of last year, the Pew Research Center noted that prices in the United States were rising faster than almost anywhere else. The United States’ inflation rate increased by 3.58 percentage points between the third quarter of 2019 (the last full economic quarter before COVID-19 was identified) and the third quarter of 2021, a larger change than in all but two of the 46 countries studied.
Of course, governments all over the world spent heavily to combat the pandemic, but few distributed cash directly to citizens as the American government did. The four Federal Reserve researchers have been tracking sharp increases in “inflation-adjusted disposable personal income,” or excess spending cash, reported by American households over the last two years. “During 2020 and 2021, U.S. households saw significantly higher increases in disposable income relative to their OECD peers,” they write.
According to the COVID Money Tracker, which is run by the Committee for a Responsible Federal Budget, a nonprofit that advocates for lower deficits, approximately $817 billion in direct payments to American households were delivered in three rounds during the pandemic. The first round of stimulus checks, worth $1,200 per person, was approved in March 2020 as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. In December of that year, another round of $600 checks was distributed.
The big blow, however, came in early 2021, when the Biden administration pushed through a round of $1,400 checks as part of the American Recovery Plan, which was approved by Congress in March 2021.
Despite the fact that each round of direct payments had slightly different criteria for determining who received the payments, much of the $817 billion ended up in the bank accounts of people who had never lost their jobs and were well above the poverty line. Households earning up to $160,000 in joint income were eligible for the final round of direct payments, which were distributed in the first half of 2021—and many progressives in Congress believed the cutoff should have been higher.
We are now reaping the benefits of what Congress has sown. All of that extra money is chasing the same number of items. That is a recipe for inflation straight out of a textbook. According to the four economists, “U.S. income transfers may have contributed to an increase in inflation of about 3 percentage points by the fourth quarter of 2021.”
Of course, this isn’t a new concept. More than a year ago, Larry Summers, one of the Obama administration’s top economic advisers, warned about rising inflation. Summers warned in a Washington Post op-ed that passing another stimulus bill in the spring of 2021 would “set off inflationary pressures of a kind we have not seen in a generation.” Other top economists, including a former International Monetary Fund chairman, issued similar warnings. The Biden administration and Democrats in Congress did not listen, and now we find ourselves in this situation.
The value of this Federal Reserve analysis is that it does not look ahead in time and try to predict what will happen, but instead examines existing data to determine what did occur. By putting more money directly into Americans’ pockets and bank accounts, inflation became worse than it would have been otherwise.
To be fair, the economists point out that a less robust response to the pandemic could have resulted in a different type of economic pain. “Without these spending measures,” they write, “the economy could have tipped into outright deflation and slower economic growth, with the consequences being more difficult to manage.”
Any serious attempt to deal with America’s current bout of inflation must be aware of the possibility of an alternate reality—the grass is not always greener on the other side.
That, however, does not absolve the federal government—from the White House to Congress to the Federal Reserve—of its role in exacerbating the situation. The entire world is experiencing high inflation, but American policymakers have added an unusually large amount of fuel to the fire.