- Republicans argue that Biden’s stimulus plan will fuel runaway inflation. Wall Street is not so worried.
- Big bank economists see that new aid only moderately raises inflation while helping the US recovery.
- UBS, BofA, Goldman Sachs and Deutsche Bank see stimulus affecting inflation in 2021 and beyond.
- Visit the Insider Business Department for more stories.
The debate over the approval of President Joe Biden’s $ 1.9 trillion aid proposal is simple.
Democrats argue that the gap in the economy is so large that it justifies spending nearly $ 2 trillion, in addition to the $ 3 trillion spent in March last year, and the $ 900 billion spent late in Trump’s term is. Republicans point to all the relief the government has already provided, saying the economy can recover with a much smaller boost. Overdoing it, they say, if you spend so much, it can bring inflation to alarming levels.
But there is a third player in the debate: the Wall Street investment banks that are hurting the math. And they are increasingly saying that concerns about runaway inflation have been misplaced.
Economists at large banks sat on the sidelines for weeks, vaguely saying that another package would achieve the goal of accelerating growth. Now that the Democrats are continuing with Biden’s large-scale plan and are likely to approve the bill by mid-March, Wall Street’s decision is unlikely to make Republicans happy.
Each large bank has its own forecast, models and a team of experienced economists, and many come to the same conclusion: the benefits of the Biden plan outweigh the risks. After a decade of weak inflation and a currently stagnant economic recovery, Wall Street is cheering efforts to expand the economy with a massive shot in the arm.
Here’s what four banks have to say about new stimulus and what inflation can come out of it.
(Spoiler: not much)
Bank of America: ‘A difficult balance, but so far very successful’
Investors have not raised the inflationary concerns surrounding stimulus. Inventories – which have historically sold out when consumer prices have overheated – are near record highs. Investors also continue to turn into underperforming companies that will bounce back as the economy reopens, indicating that they are more focused on profit growth upside down than potential inflation winds.
Michelle Meyer, head of U.S. economics at Bank of America, says it briefly and says the market paints a story of optimism.
“Market participants are looking for stronger economic growth to push up inflation, but not that the Fed is sharpening too fast,” the team said in a Friday note. “It’s a difficult balance, but so far very successful.”
The firm predicts gross domestic product growth of 6% in 2021 and another 4.5% next year. This type of expansion would fill the gap in the economy by the end of 2022, and additional stimulus would further accelerate growth, economists said.
The question is not whether the economy will overheat, but by how much, they add. The output gap – the difference between actual GDP and maximum potential GDP – is expected to reach its largest surplus since 1973 if Biden accepts its proposal, according to the bank.
As the Federal Reserve actively pursues inflation of more than 2% for a period of time, the gap in the economy is likely to be filled too much before stable growth returns, the note reads.
UBS: ‘Only rising gradually’
The White House package may exceed what is needed, but the impact on inflation is likely to be small, UBS economists led by Alan Detmeister said in a Wednesday note to clients.
The bank’s rough estimate gives rise to inflation of around 0.5 points more than a scenario where no additional support is approved.
The price is expected to rise ‘only gradually’ after ‘modest’ inflation in the first half of 2021, the team said. Core spending on personal consumption – the Fed’s preferred measure of inflation – will rise to 1.8% in 2022 and to 1.9% next year, which is still below the central bank’s target. Inflation is likely to exceed 2% after 2023 if the economy can strengthen further, UBS said.
The forecast does not yet take into account the current proposed stimulus measure, but the package carries a small upside risk and is unlikely to lead to inflation reaching 2% sooner, economists added.
Goldman Sachs: ‘Models are currently too few’
Economists led by Jan Hatzius followed a different approach, focusing on models that measure the output gap instead of inflation expectations. The measure depends on the maximum potential GDP estimates published by the Congressional Budget Office, but these estimates change over time as the US economy develops.
History suggests that the CBO’s calculations are flawed and currently have too low a pass in the U.S. economy, Goldman’s economists said Wednesday. The team claims that the office’s model suffers from endpoint bias, meaning that it interprets short-term changes as a reversal of a long-term trend.
According to the bank, economists do not have to look too far to find other examples of this. The CBO’s estimate of potential GDP was revised lower consistently from 2009 to 2017 when actual GDP weakened to maximum potential. Revisions subsequently turned positive in 2018, when actual GDP exceeded the estimated maximum. The economist reinterpreted the CBO which was apparently an overheating to later be the full potential.
“Both on the way down and on the way up, the actual GDP was therefore a leading indicator of the estimated potential GDP, indicating the bias of the end point,” they add.
Overall, Goldman projects that the output gap is currently more than twice the size of the CBO’s estimate, which supports the bank’s view that ‘inflation risk remains limited’, even with the growth estimates above. The CBO model is also difficult to compare to inflation over the past decade, Goldman said, as price growth was gradually not below the Fed’s target, even as the budget holder saw the economy overheat.
Deutsche Bank: ‘An unusual moment in macro history’
A special report Friday, Deanche Bank’s chief international strategist, Alan Ruskin, tried to find a balance. In essence, he wrote, the coming year would be too early to say.
Ruskin noted that inflation usually tends to weaken growth by as much as two years, writing that inflation fears are unlikely to be easily proven wrong or wrong in 2021.
“Some soft US inflation numbers don’t sound all that clear.” However, some strong US inflation figures will cause concern, “he wrote. “Then there is an inherent asymmetric bias in how markets will think about inflation risks going forward.”
Ruskin foresaw the fear of building up inflation for this reason, as his “everything is clear” about inflation risk will not be achievable. In the medium term, he added that the “market consequences of a significant US inflation acceleration are much greater than if inflation could not accelerate.”
Ruskin notes that this is an unusual moment in macro history, where ‘the’ stars’ are related to fear of inflation “because economists of different traditions, ranging from Neo-Keynesians to Monetarists to the Austrian school, all show growing evidence more rather than less inflation risk.
These elements include the strongest growth in money supply in history; the strongest expected real growth in 70 years; closing a large negative output gap and some of the most accommodating financial conditions recorded.
Ruskin wrote: “There is a certain feeling of ‘if not now, when then?'”