As Americans experience the highest inflation in decades, President Biden has stated that fighting rising costs is a priority for his administration. Lately, he has cited one policy in particular as an inflation-fighting tool: narrowing the country’s budget deficit.
“Reducing the deficit is one way to reduce inflationary pressures in an economy,” Biden said this month. “We’re cutting federal loans and we’re helping to fight inflation.”
The federal budget deficit – the gap between what the government spends and the tax revenues it receives – remains wide. But Biden has pointed out that it has shrunk by $350 billion during its first year in office and is expected to fall by more than $1 trillion by October, the end of this federal fiscal year.
Rather than being the result of recent fiscal moves by his administration or Congress, the deficit reduction largely reflects the rise in tax revenues from strong economic growth and the phasing out of pandemic-era contingency programs such as expanded unemployment insurance. . And for many experts, that — plus the reality that deficits have a complicated relationship with inflation — makes the fiscal gap a surprising topic of conversation.
“It’s probably not something they should take credit for,” Dan White, director of government advisory and tax policy research at Moody’s Analytics, said of the Biden team’s emphasis on deficit reduction. Expiration of the programs usually “doesn’t make things worse,” he said.
The Biden administration’s spending package in March 2021 helped the economic recovery, but it also meant that the deficit contracted less than it would have otherwise been last year. The $1.9 trillion contingency plan likely contributed to inflation, as it pumped money into the economy as the labor market began to recover and businesses reopened.
But the White House has explained its new emphasis on deficit reduction and fiscal moderation in terms of timing. Government officials argue that in March 2021, the world was insecure, vaccines were just beginning to roll out, and spending a lot of money on support programs was an insurance policy. With the labor market booming and consumer demand remaining high, the government says it wants to avoid ramping up spending in ways that could fuel further inflation.
“Supply chains have presented challenges in ramping up production as quickly as we could support demand,” said Heather Boushey, a member of the White House Council of Economic Advisers. “The point he’s trying to make is that the plan, moving forward, is responsible and not intended to add to the question.”
Moody’s Analytics estimates that inflation this year will be about a percentage point lower than if government spending remained at last year’s levels.
But few, if any, expected those programs to continue. And while it’s possible to roughly estimate how much waning fiscal support is contributing to the inflationary situation, as Moody’s did, a number of economists have said it’s difficult to know exactly how much it makes up for inflation.
Understanding inflation and how it affects you
The link between budget deficits and inflation is also more complex than Mr Biden’s statements suggest.
Deficits, which are financed by government borrowing, are not inherently inflationary: whether they push up prices depends on the economic environment and on the nature of spending or the cuts in revenue that have caused the budget deficit.
For example, policies that reduce the deficit may be inflationary. A large, widely distributed incentive that provides direct monetary aid to low- and middle-income households could be more than offset in a budget by revenues from large tax increases for the wealthy. But if much of that money is passed on to people who are likely to spend it soon, demand could outstrip supply, leading to inflation. Alternatively, spending that increases deficits — such as debt-funded investments in energy infrastructure — can reduce inflation over time as the program improves efficiency, increases capacity, or makes production cheaper.
“I fall back to the typical economist answer and say, it depends,” said Andrew Patterson, a senior international economist at Vanguard.
The last time the federal government had a budget surplus was in 2001. Since 1970, there have been only four years in which the US government has levied more taxes than it spent. During that period, there have been times of both high and low inflation.
“There’s no simple link between deficit and inflation — you have to look at both the demand and supply sides of the economy,” said Glenn Hubbard, a professor of finance and economics at Columbia University and head of the Council of Economic Advisers. under President George W. Bush. The existence or non-existence of high inflation has more to do with imbalances in the real economy than complex fiscal calculations. “If aggregate demand grows much faster than aggregate supply, you’re going to see inflation,” he said.
Complicating matters in the current situation is that the stimulus from recent years is still seeping through to the economy, as consumers have built up savings that they are scaling back, and state and local governments continue to use untapped emergency funds.
And stimulus-fuelled demand is far from the only reason prices are rising. Over the past year, factory closures and congested transit routes have made it difficult for companies to expand supply to meet booming demand. Shortages of cars, banks and building materials and raw materials have contributed to the rise in costs.
Recent global developments worsen the situation. The Chinese government’s latest lockdowns to contain the coronavirus threaten to rock factory production and shipping, while the war in Ukraine has sent fuel and food prices soaring.
Employers are also raising wages as they rush to hire people in a hot job market, and that rise in labor costs is prompting some companies to raise prices to protect their profit levels. Some companies even increase their profits because they have found that they can demand more in an era of high demand.
The drag on demand from dwindling pandemic aid does not appear to be large enough to substantially offset those other forces. To date, price increases for a range of goods and services have largely accelerated.
Frequently asked questions about inflation
What is inflation? Inflation is a loss of purchasing power over time, meaning your dollar won’t go as far tomorrow as it did today. It is usually expressed as the annual price change for everyday goods and services such as food, furniture, clothing, transportation, and toys.
Consumer prices rose 8.3 percent in the year to April 2022, just below their March high, the highest rate of increase since 1981. A closely watched measure of inflation, excluding volatile food and fuel costs resigned, increased in April compared to the previous month, a sign that price pressures remain strong.
What happens to inflation next will likely depend on the Federal Reserve’s response. The central bank is raising interest rates to make borrowing more expensive, a measure that could help supply catch up with general demand in the economy, which could moderate price increases.
But that process is likely to be an unpleasant one that could disrupt markets, drive up unemployment and even trigger a recession.
Given that bleak backdrop, the White House — while acknowledging that the Fed is primarily responsible for controlling inflation — has also emphasized that it is doing what it can to help Americans struggling to get groceries, housing and transportation. to pay.
The government has taken a number of specific price-cutting measures, including releasing oil from the Strategic Petroleum Reserve in an effort to cut gas costs and improving the domestic supply of semiconductors to reduce a deficit. But many of these efforts are either short-term moves or changes that take a long time to provide meaningful relief.
“At least they seem to be looking for ways to tackle inflation,” said Sarah Binder, a political scientist at George Washington University. Still, she said, she found the government’s new focus on the deficit unusual.
“In some ways it’s a bit surprising: most voters don’t pay that much attention to the deficit,” said Ms Binder. Gallup polls show that 17 percent of Americans say inflation is the biggest problem facing the nation, with 1 percent citing a deficit.
Either way, the government may struggle to narrow the deficit over the next few years. Two-party deals to significantly increase taxes or reduce some forms of spending have proved elusive. Pandemic spending programs have largely expired, so their expiration won’t affect the deficit as much in the future.
The Congressional Budget Office expects the deficit to widen again in 2025 in dollars and to widen again in 2026 as a share of gross domestic product.
Recently, the president promoted another idea for fighting inflation: “Make the richest companies pay their fair share.” Since his 2020 campaign, he has pushed to raise the corporate tax rate from 21 percent to 28 percent.
Some researchers say that while such changes can help reduce inflation on the margins, adjustments in taxes and spending shouldn’t be the first line of defense against a sudden price hike.
“Fiscal policy shouldn’t be your primary tool for fighting inflation,” said Louise Sheiner, policy director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution. “As far as inflation goes, it’s largely up to the Fed.”