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A thread on some back-of-the-envelope reflections on the "worst-case scenario" of overheating the economy and inflation: Starting assumptions are
1. The CBO has the output gap right
2. A very generous (linear) multiplier of 1 on $1.9 trillion in new spending
(1/6)
1. The CBO has the output gap right
2. A very generous (linear) multiplier of 1 on $1.9 trillion in new spending
(1/6)
If 1) and 2) are right, we will shoot past potential GDP and be about 6% above potential in 2021. The last time the economy was anywhere near this was Q1 1966, when by CBO’s measure output was 5.7% above potential. (2/6)
Inflation (measured as %change in the CPI-U from a year ago) did not reach above 5% until nearly 3 years later in March 1969 (graph). This was also before a much more competent(?) Fed and before the removal of Regulation Q (background: https://twitter.com/azsavov/status/1358819658120503306?s=20)
What if that is anomaly - that is, we were lucky in the late 1960s that inflation didn’t spike more? The worst-case tradeoff (ignoring all other shocks at the time!) in the data is Q4 1978, when output was 2.3% above potential and inflation rose 5.7 pts in following years. (4/6)
If this were the same trade-off as today, inflation would rise really 15 points due to the American Rescue Plan (ARP)! Is that really a reasonable scenario given our current Fed? I would argue not (yes, a cop-out for now). (5/6)
Given all this, and blind(?) faith that the Fed knows more about what it’s doing this time around, I have another reason on top of others that I’m not concerned about inflation. There may be other reasons to critique the ARP, but inflation risk isn’t one of them (6/6).
Please critique me! I wrote this because I thought it was a fun thought experiment, and perhaps useful. If it isn't, tell me why, I want to learn!
