Will the Stimulus Work? Watch These 3 Metrics
Focus on inflation expectations, monthly payrolls and core
CPE to tell whether the U.S. economy is recovering from the pandemic safely.
By Michael R. Strain
March 12, 2021, 5:09 PM GMT
The experiment is underway.
The experiment is underway. Photographer: Mandel Ngan/AFP
via Getty Images
President Joe Biden’s $1.9 trillion relief and stimulus bill
sets the U.S. off on a great economic experiment.
It will test how much fiscal stimulus the U.S. economy can
absorb after a year of pandemic anxiety, social distancing and lockdowns, when
households are sitting on a pile of cash that they are eager to spend while
seeing friends and family, and with output rising and unemployment falling.
The policy debate about Biden’s plans has been surprisingly
high quality, with supporters and critics alike offering solid arguments for
and against the threat of damaging inflation and the likelihood of a solid and
sustained recovery. It’s not surprising that economists disagree, given the
massive uncertainty about the economy’s performance in the coming year.
I have been a critic, voicing concerns about inflation even
before Biden took office. How will we know which side of this debate was right?
I’ll be paying particular attention to three metrics:
Inflation expectations. Investors now expect prices to rise by an average of 2.5% over the next five years. If they’re right, that would be a policy victory. But if their expectations climb to 3%, my concern about the possibility of damaging runaway inflation will grow. And if it crosses 3% and stays above it, I would expect the Fed to attempt to slow the recovery.
Unfortunately, the conditions for this to happen are ripe. The economy will be running very hot in 2021, with demand growing faster than supply can keep up. The Federal Reserve has adopted a blasé attitude about future inflation. And Congress seems remarkably unconcerned about the dangers of deficit spending, and is already talking about spending trillions more this year.
If the fiscal and monetary authorities are unconcerned about inflation, markets might expect more of it. It is useful to interpret market expectations about the next five years in light of the inflation outlook for the following half-decade. This metric is also elevated. But it is much lower than the five-year expectation, standing at a bit above 2%.
Taken together, the
story is clear: Investors expect prices to grow more rapidly than the Fed’s
target over the next five years (2.5%), but in the five years after that, they
expect a return to the Fed’s 2% goal. This is a Goldilocks situation.
Monthly payroll employment gains.
The economy was down 9.5 million payroll jobs last month relative to February 2020, the month before the pandemic began. The economy won’t have fully healed from the pandemic until all those jobs are back. If things go right, the economy will be back to full employment around the end of 2022, adding around 500,000 net new jobs each month.
But there’s a risk that the jobs boom will be too front-loaded, if virus-sensitive industries like leisure and hospitality aggressively spring back to life in the next six months. And there is the risk that the generous unemployment benefits in Biden’s stimulus hold the labor market recovery back.
The rule of thumb I’ll be using is whether monthly gains are above or below 500,000. If the economy consistently adds, say, 1 million jobs per month, then I’ll be worried about demand-side overheating.
If the economy regularly adds around 250,000 jobs per month, I’ll be worried about unemployment benefits holding back the supply side of the economy in the face of rapid demand. I’ll also be interpreting data on job gains in light of inflation expectations. If the economy can add 1 million jobs per month without expectations climbing, then the Biden stimulus will be succeeding.
Inflation. There are many measures of inflation, but I’ll be
paying especially close attention to the price index for personal consumption
expenditures, excluding the volatile food and energy categories. That measure —
called “core PCE” — hasn’t been above the Fed’s 2% target since December 2018,
and in January clocked in at 1.5%. Though it is the Fed’s preferred measure of
inflation, it gets less attention than the Consumer Price Index. And the CPI
typically registers faster price growth than the core PCE. On top of that, oil
prices will push up the CPI, but won’t affect core PCE. This will add to the
Fed’s already considerable communications challenges. It will be a policy
victory if core PCE hits 2.5%. But a month here or a month there of eye-popping
inflation — in the 4% or 5% range — will make me nervous that the Fed will act
to slow the recovery.
I’ll be looking at lots of other measures, too. Long-term
unemployment has enormous costs to workers, so reducing its ranks is a top
priority. The length of the average workweek is a good indicator of whether
businesses are ramping up output and seeing increases in demand for their
products and services. The unemployment rate is the single best statistic to
determine how much slack is in the labor market. The yield on 10-year Treasury
bonds indicates investors’ views on the economy’s prospects for growth. The
rate of workforce participation will tell whether workers who have left the
labor market due to the pandemic are returning.
The president’s experiment could be a big success, rapidly
getting millions of workers back into jobs instead of making them wait a few
more years for a full pandemic recovery. It also could end poorly, with
inflation taking off or the Fed slowing the economy out of concern about
consumer price increases and frothy financial markets.
These indicators will help tell the story of the most
ambitious — or reckless — fiscal policy decision in living memory.
This column does not necessarily reflect the opinion of the
editorial board or Bloomberg LP and its owners.
To contact the author of this story:
Michael R. Strain at mstrain4@bloomberg.net
To contact the editor responsible for this story:
Jonathan Landman at jlandman4@bloomberg.net
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