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State of the Economy

Inflation small price to pay for economic recovery

Lockdown recession could have been a decade-long depression


There is a lot of noise right now concerning inflation. People point to the rapidly rise prices, starting June last year and cumulating in a rate of 6.9 percent this November. This is the highest rate since June 1982. People are getting upset.

To which I respond, Come on people! Get real! We just suffered through the worse economic downturn ever recorded. Unemployment was 14.8 percent, GDP dropping 9 percent, prices not rising but falling 2 percent. The economy in disarray. And yet after less than two years, GDP is fully recovered, people are back to work, the unemployment rate is now only 4.2 percent. The side effect of this amazing recovery is inflation. It could have been much, much worse.

The current inflation arises initially from the supply disruptions caused by the pandemic lockdown. Factory closings, port disruptions, social distancing, pandemic-driven shifts in product demand, all these led to reduced output and higher prices.

An option would have been to just let the supply disruptions work their way through the economy. The consequence would have been persistent high unemployment over several years. Eventually, the inflation would have slowed, then reversed. The suffering among those who lost their jobs, who would have been predominately among the working class, would have been immense.

Not surprisingly, our political leaders, Democrat and Republican alike, decided that doing nothing wasn’t an option. The Fed took action to ensure adequate liquidity. Interest rates dropped to near zero. These low rates allowed continued borrowing and spending that help offset the supply disruptions and kept people employed, but it also further contributed to inflation.

On the fiscal side, there was a bipartisan consensus of the need for massive increase in spending. The spending was aimed at both mitigating the immediate economic impact of the pandemic —unemployment extension, The Payroll Protection Program — and at providing stimulus to the economy. In the second category of spending were the three stimulus checks.

The spending in these bills was truly massive, about $6 trillion dollars with $4 trillion enacted under President Trump and about $2 trillion under President Biden, most passed with bipartisan majorities. The spending amounted to a whomping 30 percent of GDP. The CARES Act by itself, passed under Trump, at $1.9 trillion, is the largest single economic stimulus package ever enacted.

The stimulus checks and extended unemployment insurance were particularly important for ensuring the continued spending by lower- and middle-income households. Maintaining household spending, in turn, was critical for ensuring small business had customers to sell to. Similarly, the Payroll Protection Program, which made direct payments in the form of forgivable loans, was also critical to the survival of many small businesses.

But these programs, along with other provisions of the stimulus packages are inflationary. By maintaining demand in the face of supply disruptions, the stimulus programs contributed to upward pressure on prices.

Going forward, the Fed has signaled higher interest rates. Most experts expect two or three rate hikes during 2022. Meanwhile, many of the programs funded by the economic stimulus packages are set to expire. Higher interest rates and declining federal spending should blunt future inflation. I expect inflation to be tamed by the end of 2022; that is, back under 3 percent.

Let’s be frank. We are extremely fortunate that the lockdown recession didn’t transform into a depression. We can thank the very aggressive fiscal and monetary policy for this. The byproduct of these programs is the inflation we now suffer. Better inflation than depression.

Christopher A. Erickson, Ph.D. is a professor of economics at NMSU. His signature course is “money & banking,” which he has taught 150 times over 38 years. The opinions expressed may not be shared by the regents and administration of NMSU. Chris can be reached at chrerick@nmsu.edu.