The question is whether that fast-paced rebound can be made to last, freeing the nation from the low-growth rut it has plowed for most of the past 20 years, or will instead ignite the sort of inflation that has not been seen since the 1970s. Prominent economists such as former Treasury Secretary Larry Summers already are warning that potential overheating could end in a new recession.
After 20 years of subpar growth, the odds are against a prolonged boom. But the pandemic has catalyzed new thinking about both fiscal and monetary policy, creating the most favorable conditions for restoring vigorous economic growth in several decades.
“In terms of history, this is a unique situation,” said Chetan Ahya, chief economist for Morgan Stanley, who recently advised clients to prepare for a fast-growing “high-pressure economy” through at least the end of 2022.
The Biden administration plans to spend $1.9 trillion backstopping growth on top of the $3.7 trillion in federal funds that have flowed since March, helping all but guarantee years of massive government borrowing to spur the economy.
At the same time, the Federal Reserve says it will keep interest rates near zero even if inflation creeps above the central bank’s annual target of 2 percent, making it easier for businesses and consumers to borrow.
Not for 75 years, since American G.I.s were battling two totalitarian empires, has the economy been boosted simultaneously by so much deficit spending and so much easy money. The economy will enjoy additional support this year from consumers, who have more than $1.6 trillion in excess savings, thanks in part to last year’s stimulus checks, according to Bank of America.
As President Biden seeks congressional approval of fresh pandemic relief, he plans other moves to boost the economy’s long-term prospects. Administration officials are drawing up an ambitious spending package that would provide up to $3 trillion for a range of Democratic priorities, including infrastructure, clean energy, domestic manufacturing and child and elder care.
The U.S. economy, most experts say, clearly needs a push to re-create the kind of growth that made Americans so prosperous in the last half of the 20th century. Over the past 20 years, by contrast, the U.S. economy grew at an average annual rate of just 1.9 percent, well below the 3.5 percent figure between 1980 and 2000.
Expanding the labor force — either through immigration or by making it easier for women to return to work — and modernizing the nation’s infrastructure would deliver faster long-term growth, many economists said. Growing over the next decade at an annual rate of 2.5 percent rather than the tepid 1.8 percent pace the Congressional Budget Office expects would produce nearly $11 trillion in additional economic activity.
“Policies make a difference,” said economist Julia Coronado, president of Macropolicy Perspectives. “There’s scope to move toward a higher run rate.”
The current situation bears little resemblance to the government’s response to the 2008 crisis, which produced the most anemic recovery in U.S. history. The Bush and Obama administrations deployed more than $2 trillion to save the economy, but within months of the recession’s official end in June 2009, the United States began reducing the federal deficit, which sapped the economic rebound.
The deficit fears that colored that era’s policy debates today are less potent. Investors require just 1.3 percent interest to lend money to the government for 10 years, one-third of what they demanded in 2009.
Republican lawmakers still warn against lavish government spending. But after agreeing to add more than $5 trillion to the national debt during the Trump administration, their complaints may carry less weight.
Biden, in any event, seems determined to avoid repeating the mistake of premature austerity.
“Now is the time to go big,” the president said during a CNN town hall this week.
The Fed also has revolutionized its approach to managing the economy. For decades, the central bank had believed that if unemployment fell too low, inflation would rise, requiring it to pump the brakes by raising interest rates.
But as the economy recovered from the Great Recession, unemployment declined to half-century lows without inflation reaching the Fed’s 2 percent price stability target.
After raising rates in 2018 to head off price increases that never materialized, the Fed pivoted to cutting them in 2019. Fed officials also set out on a national listening tour to hear from communities that hadn’t reaped the benefits of “full employment.”
In August, the Fed announced it no longer would be so quick to raise rates. Instead, central bank officials will allow the jobless rate to fall until inflation exceeds its 2 percent target for a temporary, but unspecified period of time in order to get more Americans in the workforce.
The new framework is rooted in the lesson of the final pre-pandemic months, when wage gains began reaching lower-income workers who until then had missed out on the expansion’s benefits. Fed officials concluded they “could do more to tighten the labor market than we previously thought was possible,” said Skanda Amarnath, research director at Employ America, a left-leaning think tank.
Still, there are risks with running the economy hot. Summers, who was also an economic adviser to the Clinton and Obama administrations, warned earlier this month that Biden’s $1.9 trillion relief bill could “set off inflationary pressures of a kind we have not seen in a generation.”
Olivier Blanchard, former chief economist of the International Monetary Fund, also has warned that the legislation is too large and risks triggering inflation that would cause the Fed to raise interest rates and likely send the economy into recession.
If demand for goods and services rose too fast, eventually the pool of unemployed workers would be exhausted and factories would be stretched. Beyond that point, wages and prices could begin climbing, repeating the experience of the late 1960s, when President Lyndon B. Johnson famously refused to choose between the “guns” of the Vietnam War and the “butter” of his Great Society domestic agenda. By 1969, prices were increasing at an annual rate of 6.2 percent, up from just 2.4 percent two years earlier.
A similar situation today would almost certainly cause the Fed to raise its benchmark lending rate, a move that often leads to recession.
Powell and Treasury Secretary Janet Yellen, a former Fed Chair, have dismissed those concerns. Despite the decline in the official jobless rate, roughly 10 million fewer Americans are working today than were employed last February. More aid from Congress plus a spike in consumer spending could cause “some upward pressure on prices” but it “will be neither large nor sustained,” Powell said.
“We are still very far from a strong labor market whose benefits are broadly shared,” the Fed chair said last week.
But Robin Brooks, chief economist for the Institute of International Finance, an industry group, said financial markets are beginning to register concern. One measure of inflation expectations, the 10-year treasury break even rate, has jumped since the November election to 2.2 percent, its highest level in more than two years.
“That thing is screaming,” Brooks said. “Perhaps we’re overdoing it.”
At issue is how far below its potential the economy is operating, a measurement that economists call “the output gap.” Those who worry about overheating say the economy was operating close to its limits before the pandemic hit and would be pushed beyond them by Biden’s plan.
CBO says the economy now is about 3 percent below its potential. But using a different calculus, Goldman Sachs this week pegged the gap at 6 percent.
“Trying to estimate potential growth is more an art than a science,” said Megan Greene, global chief economist at the Harvard Kennedy School of Government.
Indeed, over the past two decades, CBO scorekeepers have repeatedly lowered their assessments of the economy’s ability to grow without sparking inflation. Throughout 2018 and 2019, CBO said the economy was operating above its sustainable path. Yet the unemployment rate declined from 4.1 percent at the end of 2017 to 3.5 percent in February 2020, while inflation stayed tame.
One year ago, the economy was largely healthy. Unemployment of 3.5 percent was near a half-century low amid a record-long expansion.
The recovery from the pandemic crash, which pushed unemployment to nearly 15 percent in April, has been faster than expected. Thanks to multiple rounds of federal relief last year, the economy should rise “meaningfully above its pre-covid-19 path” later this year and total output will be higher next year than economists expected before the pandemic, according to Ahya.
But Biden’s “build back better” program aims to create an economy that exceeds the February 2020 model, with reduced income inequality and greater opportunities for women and disadvantaged minority communities.
“There’s now an increased focus not just on aggregate GDP, but how it’s spread across the population [and] addressing inequality and racial justice,” Coronado said. “It’s not just about the growth numbers and the stock market.”
To make that a reality, additional spending beyond the $1.9 trillion relief bill will be needed. Even before that legislation has cleared Congress, the administration is talking up a potential $3 trillion infrastructure package, which faces an uncertain reception on Capitol Hill.
Launching the economy onto a permanently higher trajectory also will require worker retraining, expanded child care to allow women forced from the labor force by the pandemic to return to work, and updated bridges, ports and broadband connections, Greene said.
As millions of Americans each week get vaccinated against covid-19, the economy is stirring. Retail sales in January jumped by more than 5 percent — their best showing since June — while industrial production rose for the fourth straight month.
“The whole economy is going to grow in a way that we haven’t seen it grow in a long time,” the president said Wednesday. “This is the time for us to move.”
Rachel Siegel contributed to this report.
