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If this increase in demand could be accommodated, it would lead to a level of output at 14% above potential. It would take the unemployment rate very close to zero.
This would not be overheating; it would be starting a fire.
This would not be overheating; it would be starting a fire.
If it were to happen, it would lead to strong inflation (not the 2.5% that some predict, but potentially much more), and, likely a strong reaction of the Fed to limit the overheating, a very large increase in interest rates, again far more than is currently priced in.
Why go there? Why force the Fed to in effect cancel some of the Biden package?
Could I be wrong and too pessimistic? Sure. Multipliers could turn out to be very small, maybe 0.25. I see no strong reason for it.
Could I be wrong and too pessimistic? Sure. Multipliers could turn out to be very small, maybe 0.25. I see no strong reason for it.
Potential output could be much higher, say half a trillion higher. I see no strong reason for that either. Or demand may be very weak for other reasons. Again, I do not see why. But it could happen, and everything would turn out fine. The question remains: Why take the risk?
Let me be clear. We should spend what we need to save people from poverty and fund the needed response to the pandemic. I think we do not need to spend 1.9 trillion for that, and we should have a smaller program. But suppose we did need to spend that.
Why couldn’t we finance it partly by an increase in taxes, say an exceptional tax on capital gains, given that the stock market has done so well in the recent past? This would be fair, deliver protection and limit overheating. Wouldn’t this be a better way?
