Was Big Stimulus a Big Mistake?

U.S. economic policy in 2021 was met with a firestorm of criticism from many economists. I’m not talking just about Republican loyalists, who always predict disaster when a Democrat moves into the White House. Even Democratic economists, or relatively apolitical technocrats, were scathing in their denunciations.

Thus Larry Summers, who was effectively the Obama administration’s chief economist, blasted President Biden’s spending bills as the “least responsible macroeconomic policy we’ve had in the last 40 years.” Mohamed El-Erian, an economist who is usually cautious in his pronouncements, declared that the Federal Reserve had committed a historic error by failing to raise interest rates in 2021.

Underlying these harsh words was the belief not only that we would go through a period of high inflation — which the critics got right, and I got wrong — but also that getting inflation back under control would be extremely painful, probably involving years of very high unemployment.

But the economy has defied that dire prediction. Inflation has come way down despite continuing strength in employment. If the policy choices of 2021 did any lasting damage, it’s invisible in the data. So let’s talk about where the economy is now, and ask what, if any, lasting damage the Biden administration’s early policy may have done.

The first point is that we’ve experienced remarkable progress against inflation, so much progress that it seems almost surreal even to optimists like myself. One good way to see the good news is to compare some standard estimates of “underlying” inflation (that is, measures that try to extract the signal from the noise) over different time horizons. Here are two such measures for the Fed’s preferred inflation indicator, the personal consumption expenditure deflator — one that excludes volatile food and energy prices (below left), and one that excludes all large price movements (below right):

Credit…Bureau of Economic Analysis, Dallas Fed

Both yield almost the same result: inflation below 3 percent for the past three months, lower than the rate over the past six months, which in turn is below the rate over the past year. This is what you expect to see if inflation is falling steadily toward something close to the Fed’s 2 percent target.

I still often see statements to the effect that while we’ve made progress against inflation, there remains a lot of work to be done. But the data says that we’re almost there, and inflation pessimists seem to me to be engaged in almost desperate efforts to find justifications for their pessimism.

And all this progress has been achieved at no visible cost in terms of jobs. In fact, employment recovered with stunning speed from the Covid slump. Here’s one measure, the employed percentage of adults ages 25 to 54, comparing developments since January 2020 with those after the last recession began, in December 2007:

Credit…Bureau of Labor Statistics

Last time it took more than a decade to achieve a full employment recovery. This time we were above pre-Covid employment within three years. Disinflation hasn’t seemed to require any sacrifice at all, let alone the high “sacrifice ratio” — lots of unemployment to reduce inflation — that many predicted.

Still, hasn’t inflation eaten into workers’ paychecks? Actually, no.

Wage data have been tricky over the past few years. During the worst of the pandemic shutdowns, job losses were concentrated among lower-paid service workers, so that the average wage shot up simply because the worst-paid were not part of the average, then came down as things returned to normal. At this point, however, most of these effects are probably behind us. And the real wage of the average worker — average hourly earnings divided by consumer prices — is higher now than before the pandemic. Prices are higher, but they have been outpaced by wages:

Credit…Bureau of Labor Statistics

Today’s economy, then, seems to be in pretty good shape. There was an inflation surge in 2021-2022, but it appears to have been, yes, transitory. So did policymakers truly commit a historic error by failing to act sooner against inflation?

In fact, there’s a good economic case to be made that a temporary burst of inflation was just what the doctor ordered. The pandemic was a huge shock that disrupted supply chains and shifted the mix of goods and services consumers demanded. As a result, it was necessary for the prices of some goods to rise relative to the prices of others. And it was easier to achieve this adjustment in relative prices by raising the prices of goods that were in short supply rather than cutting the prices of goods that weren’t. A limited inflationary burst, like the one that followed World War II, was arguably the right response — at least in strict economic terms.

If you want to argue that policymakers made a historic mistake in 2021, I think that case has to rest on the proposition that even a temporary inflation burst did lasting psychological, or maybe even more important, political damage.

There’s no question that public perceptions of the economy are vastly worse than the economic reality. When I first began making this argument I got a lot of pushback from journalists arguing that the public had good reason to feel bad. At this point, however, it’s more or less impossible to deny that there’s something strange about the public’s negative view about a very good economy.

There are probably multiple reasons for this disconnect, but one possibility is that the sudden re-emergence of inflation shocked Americans who had grown accustomed to price stability, and that they still haven’t recovered from that shock.

If that’s true, it might be that the policies of 2021 were good economics but bad politics. This view, however, depends on how much of the acceleration in inflation can be attributed to those policies, which isn’t totally obvious.

There have been some efforts to model this question, for example a Bloomberg analysis suggesting that even if the Fed had moved sooner it wouldn’t have made much difference. At this point, however, there’s so much disagreement among economic modelers that I don’t think appealing to model results will persuade anyone.

One alternative is to compare inflation in the United States with inflation in other countries that didn’t engage in big fiscal stimulus. Critics of U.S. policy used to mention lower inflation in Europe as evidence that excessive stimulus was the problem. At this point we actually have much lower inflation than the Europeans, but to be fair they were hit harder by the effects of Russia’s invasion of Ukraine. Still, even before the invasion European inflation was on the rise, although lagging the United States:


Notice, by the way, that I’ve been careful to use comparable inflation measures here.

This comparison suggests that since inflation in America was a couple of points higher than inflation in Europe before Ukraine, its peak might have been a couple of points lower without those expansionary policies. Would that have led to a radically different public view of the economy? I doubt it.

So, should fiscal stimulus have been smaller? Yes. Should the Fed have started raising rates sooner? Yes. Would any of that have made much difference to the pretty good place we’re in economically, or the bad place we’re in politically? Probably not.

Quick Hits

June 2022 wants its talking point back.

Business expectations of future inflation are way down.

So is the percentage of businesses reporting price increases.

Inflation readings: Beware the noise.

Facing the Music


Not about inflation.

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