Inflation is a real risk
There are many reasons, Larry Summers argues, why inflation is now becoming a serious risk for the US economy. Just to mention a few:
- The consumer price index rose at a 7.5 percent annual rate in the first quarter, and inflation expectations jumped at the fastest rate since inflation indexed bonds were introduced a generation ago;
- Higher minimum wages, strengthened unions, increased employee benefits and strengthened regulation, although desirable, have pushed up business costs and prices;
- President Biden’s stimulus was excessive and mostly driven by political considerations. As a result, the overheating of the US economy is a distinct possibility.
The inflation risk is real
By: Larry Summers – Harvard University
Is the current increase in inflation just a blip?
In this paper Ray Fair estimates the price equations from the US macroeconomic model he has developed. He uses data available for the first quarter of 2021, so the forecast period begins with the second quarter of 2021 and ends in the fourth quarter of 2023. His conclusions:
- The stimulus from the American Rescue Plan Act combined with large wealth effects from past household saving, rising stock prices, and rising housing prices is large and it is forecast to drive the unemployment rate down to below 3.5 percent by the middle of 2022;
- Given this stimulus, the inflation rate is forecast to rise to slightly under 5 percent by the middle of 2022 and comes down slowly. If UR (unemployment rate) is used in the price equation rather than 1/UR, the inflation rate rises to slightly under 4 percent;
- There is considerable uncertainty in the point forecasts, especially two years out. The probability that inflation will be larger than 6 percent next year is estimated to be 31.6 percent;
- If the Fed were behaving as historically estimated by the Fed rule, it would raise the interest rate to about 3 percent by the end of 2021 and 3.5 percent by the end of 2022. This would lower output growth, raise the unemployment rate, and lower inflation, although lowering inflation takes time. By the middle of 2022 inflation is about 1 percentage point lower.
What Do Price Equations Say About Future Inflation?
Author: Ray C. Fair
From: Yale University
