If there were any doubt that Joe Biden’s economic proposals represent a big break with the policies of the Obama and Clinton Administrations, the debate about Biden’s $1.9 trillion COVID-19 relief plan dispelled it. For good or ill—and, in my view, it is very positive—the Biden White House is pursuing a bold and aggressive program of Keynesian economic management, the likes of which Washington hasn’t seen since the nineteen-sixties.
The argument began, last week, with a warning about the Biden plan from Lawrence Summers, the Harvard economist who served as the Secretary of the Treasury toward the end of the Clinton Administration and as the director of the White House National Economic Council during Obama’s first term. Whatever good the Biden spending package might do in boosting output, wages, and profits, Summers wrote in the Washington Post, it was so large that it could also “set off inflationary pressures of a kind we have not seen in a generation, with consequences for the dollar and financial stability.” Over the weekend, Olivier Blanchard, a former chief economist at the International Monetary Fund, seconded Summers’s concerns, tweeting, “The 1.9 trillion program could overheat the economy so badly as to be counterproductive.”
Appearing on CNN’s “State of the Union,” on Sunday, the Treasury Secretary, Janet Yellen, didn’t entirely dismiss the argument that Summers and Blanchard put forward. She said that the possibility of inflation picking up as the economy rebounds from the pandemic was “a risk that we have to consider,” but she also insisted that policymakers have the “tools to deal with that risk if it materializes.” Delighting Democrats who want to break with the past, Yellen emphasized the need to pull the economy out of its COVID-19 slump rapidly and restore full employment. Citing a Congressional Budget Office study that predicted that the jobless rate wouldn’t return to its pre-pandemic level until 2025, she said, “There is absolutely no reason why we should suffer through a long, slow recovery.” CNN’s Jake Tapper pressed Yellen on how quickly the Biden plan might bring down the jobless rate, which is now at 6.3 per cent. (Before the pandemic, it was just 3.5 per cent.) Given the danger of making a bold promise that opponents could seize upon, most politicians would have punted on Tapper’s question. Yellen tackled it head on. “I would expect that if this package is passed we will get back to full employment next year,” she said.
This prediction may have been partly designed to win support for the Biden plan on Capitol Hill. However, it also reflects an important change in economic thinking on the part of Yellen and other Biden economic advisers, some of whom harbor painful memories of the slow-paced Obama-era recovery from the Great Recession of 2007-09. Based on the severity of the current crisis, and the experience of the past decade, the Biden team is tossing out, at least for now, the textbook model of economics that policymakers have relied on for decades.
As an economic counsellor to Bill Clinton during the nineteen-nineties, and then as chair of the Federal Reserve Board, from 2014 to 2018, Yellen paid lip service to this model, which dates back to theoretical work done by the economists Milton Friedman and Edmund Phelps in the nineteen-sixties. In its most simplistic form, the model says that there is a strict lower limit for unemployment and a strict upper limit for G.D.P. growth, and that these limits can’t be violated without sparking an inflationary spiral. In issuing their warnings, Summers and Blanchard were effectively arguing that a post-coronavirus economy, revved up by widespread vaccinations and another $1.9 trillion in stimulus, could well breach these speed limits, with potentially disastrous results.
As always in economics, the proof of the pudding is in the eating. The only definitive way to find out whether the inflation threat is real or chimerical is to pass the $1.9 trillion package and see what happens. Still, the Biden Administration’s determination to go big reflects at least three persuasive counter-arguments to the Summers-Blanchard line. Despite some progress on the vaccination front, the future path of the pandemic remains uncertain. Even if the number of infections does fall rapidly, and G.D.P. growth rebounds sharply, experience suggests that the economy’s speed limits aren’t nearly as strict as the textbooks make out. Moreover, even if we do end up breaching these limits, the benefits, in terms of job creation and higher wages, could well exceed the costs, in terms of inflation. In other words, a bit of economic overheating could be a good thing for most Americans.
Back in 2014, when Yellen became the chair of the Fed, the Congressional Budget Office produced an estimate of roughly 5.5 per cent for the rate of unemployment at which inflation would start to take off. (Even the most ardent defenders of the old model conceded that the exact threshold was uncertain.) Yet, during Yellen’s four-year tenure as Fed chair, the unemployment rate tumbled from 6.2 per cent to 3.9 per cent—and for most of the time the inflation rate remained below the target rate of two per cent. After Yellen left the Fed, the jobless rate fell even further, and inflation still didn’t pick up much: in December, 2019, the inflation measure that the Fed monitors most closely stood at just 1.6 per cent—no sign of overheating there. Defenders of the traditional model sought to rationalize this departure from its predictions, but the fact was that they simply didn’t know what the economy’s real speed limit was. That’s still true today.
We can be certain that the economy has lost nearly ten million jobs since this time last year, and the employment-to-population ratio—the broadest measure of the tightness in the labor market—has declined by 3.7 percentage points. Both of these figures back up Yellen’s point that there is a great deal of economic ground to be made up. Another thing we know for sure is that running the economy hot—that is, with a very low unemployment rate—would be good for American workers, particularly those earning low wages. When labor is scarce, employers have to pay higher wages to attract and retain it. After many years of stagnating, American wages finally picked up around 2015, and, since then, some of the biggest gains for workers came among the lowest paid. In 2019, when the jobless rate hit historic lows, the wages of those in the bottom decile of the wage distribution rose by 5.7 per cent—the biggest jump in many years.
Among economists, there is some debate about the relative importance of a low unemployment rate and state-level hikes to the minimum wage in sparking such wage growth. Nearly everyone agrees, however, that the tight labor market played an important role—and Biden’s economic advisers are keenly aware of this lesson. History “shows that lower-income workers—and Black and brown workers—see the largest wage gains when the economy is at full employment,” Jared Bernstein and Heather Boushey, two members of the White House Council of Economic Advisers, wrote in a blog post last week. Getting “back to full employment, as quickly as possible, will make a major difference in the lives of tens of millions of people, particularly those most at risk of being left behind,” Bernstein and Boushey added.
The message implicit in the Biden plan is that prior Democratic Administrations have been too modest in their ambitions and too committed to the old orthodoxy about the relationship between inflation and unemployment. Biden’s advisers haven’t made this argument explicitly, but Josh Bivens, an economist at the Washington-based Economic Policy Institute, laid it out clearly last week. “The U.S. economy has run far too-cool for decades, and this has stunted growth and deprived millions of potential job opportunities and tens of millions of potential opportunities for faster pay raises,” Bivens wrote, praising the Biden plan. Ever since the inflation of the nineteen-seventies, policymakers, led by the Fed, have sought to exert downward pressure on rising prices, a policy of “opportunistic disinflation,” Bivens noted. “The Biden plan is essentially the reverse of opportunistic disinflation—it’s opportunistic go-for-growth.”
As such, it marks a return to an older Keynesian tradition, which dominated economic policymaking in the nineteen-sixties, when the U.S. government sought to keep unemployment at very low levels to spur wage growth and capital investment. (In 1968, the jobless rate hit 3.4 per cent.) Skeptics will point out that this period ended with rising inflation and higher unemployment—the phenomenon known as stagflation. As Yellen made clear, the Biden Administration hasn’t discounted the risks of going big. But its policies are based on the conviction that these risks are far less serious than the danger of not doing enough to revive the economy and alleviate the suffering that Americans have endured over the past year. “We have got to address that,” Yellen said on CNN. “That’s the biggest risk.”
