It has been said that President Biden's economy is now "stuck between a rock and a hard place". But to understand why it is being described that way, we need to understand how we got here. How we got here is a story of failure.
The story of that failure begins, as many of these stories do, with the people responsible for it attempting to justify the actions they took that contributed to it. In Washington, D.C., that means the story begins with an anonymous official within the Biden administration who is trying to put the best possible face on the situation by claiming they only had the best of intentions.
Biden set out to use the COVID-19 aid dollars to get people back to work quickly and prevent the typical "scarring" in recessions that can leave people earning less for the rest of their careers and, in some cases, permanently jobless. He succeeded at that mission as the economy has about 4 million more jobs than the Congressional Budget Office forecasted it would at this stage.
A White House official said the policies were designed with the specific goal of bringing jobs back faster than in past recoveries. After the Great Recession began at the end of 2007 and the economy crashed, it took more than six years for the total number of U.S. jobs to return to pre-downturn levels. In the pandemic recovery, the jobs total rebounded to its prior level in a little over two years.
The official, who spoke on condition of anonymity to discuss private conversations, said Biden's goal was to spur a burst of hiring that would cause strong growth in the long term. If the jobs recovery had dragged on, some people would give up hope and drop out of the labor force, reducing the ability of the economy to grow for decades to come.
What could possibly go wrong with such noble intentions?
Alas, in seeking to boost the jobs numbers by so much so quickly, the Biden administration's plan to overshoot the economy's output gap to obtain that outcome unleashed inflation with all its negative and cascading consequences. That persistent inflation wasn't supposed to happen according to the extremist activists who most fervently pushed the "Go Big" stimulus plan the Biden administration ultimately adopted. They claimed conventional measures of the output gap were flawed and they assumed the economy's potential GDP and its output gap were much larger than those mainstream estimates indicated. Arguing that was the case, they asserted little to no inflation would result from their plan for a super-sized stimulus.
That proved to be a bad assumption.
That assessment is confirmed by Paul Krugman, perhaps the most respectable backer of the "Go Big" plan, and so far, the only backer who has since acknowledged that assumption was badly wrong. The following excerpts from his July 2022 mea culpa describe what he was thinking at the time and the lesson he's learned from the failure:
In early 2021 there was an intense debate among economists about the likely consequences of the American Rescue Plan, the $1.9 trillion package enacted by a new Democratic president and a (barely) Democratic Congress. Some warned that the package would be dangerously inflationary; others were fairly relaxed. I was Team Relaxed. As it turned out, of course, that was a very bad call....
Those of us on Team Relaxed argued, however, that the structure of the plan would lead to a much smaller surge in G.D.P. than the headline number would suggest. A big piece of the plan was one-time checks to taxpayers, which we argued would be largely saved rather than spent; another big piece was aid to state and local governments, which we thought would be spent only gradually, over several years.
We also argued that if there were a temporary overshoot on G.D.P. and employment it wouldn’t sharply increase inflation, because historical experience suggested that the relationship between employment and inflation was fairly flat — that is, that it would take a lot of overheating to produce a big inflation surge....
Even so, historical experience wouldn’t have led us to expect this much inflation from overheating. So something was wrong with my model of inflation — again, a model shared by many others, including those who were right to worry in early 2021....
In any case, the whole experience has been a lesson in humility. Nobody will believe this, but in the aftermath of the 2008 crisis standard economic models performed pretty well, and I felt comfortable applying those models in 2021. But in retrospect I should have realized that, in the face of the new world created by Covid-19, that kind of extrapolation wasn’t a safe bet.
Krugman's mea culpa is a model to follow for all professionals who takes economics as a science seriously. Unlike the ideologically-motivated activists who refuse to acknowledge the role they and Biden's COVID stimulus had in contributing to the inflation that followed its implentation, Krugman can do what they are unwilling to admit. He can honestly acknowledge the Biden administration's choice to overshoot the output gap and run the economy "hot" helped make the inflation that followed and learn from that failure:
Much, although not all, of the inflation surge seems to reflect disruptions associated with the pandemic. Fear of infection and changes in the way we live caused big shifts in the mix of spending: People spent less money on services and more on goods, leading to shortages of shipping containers, overstressed port capacity, and so on. These disruptions help explain why inflation rose in many countries, not just in the United States.
But while inflation was confined mainly to a relatively narrow part of the economy at first, consistent with the disruption story, it has gotten broader. And many indicators, like the number of unfilled job openings, seem to show an economy running hotter than numbers like G.D.P. or the unemployment rate suggest. Some combination of factors — early retirements, reduced immigration, lack of child care — seems to have reduced the economy’s productive capacity compared with the previous trend.
These factors were either ignored or given short shrift by the partisans who dismissed the conventional measures that indicated the output gap would be greatly exceeded by the "Go Big" stimulus measure. Since Krugman's acknowledgment, more evidence has accumulated these factors may have been decisive in shaping how the economy responded to the American Recovery Plan Act's massive stimulus spending.
Earlier this month, the nonpartisan Brooking Institution's Lauren Bauer, Wendy Edelberg, Sara Estep, and Brad Hershbeln released a study backed by data that points to many of the same factors Krugman identified as contributing to inflationary pressures. In a separate analysis, the U.S. Chamber of Commerce's Stephanie Ferguson identified many of the same inflationary factors at work.
Meanwhile, another study released days earlier by the Brooking Institution's Katharine Abraham and Lea Rendell provides a demographic explanation for why the pandemic recovery for the labor force has played out the way it has and why improvements in the labor force participation rate are now mostly over:
Almost all of the remaining shortfall in U.S. labor force participation is the result of demographic and other trends that predate the COVID-19 pandemic, according to new research that suggests little chance that growth in the number of workers will help ease a tight American job market.
After accounting for factors such as population aging and changes in education that influence people's willingness to work, the study showed that U.S. labor force participation was only about 0.3 percentage points short of where it would have been without the pandemic - equivalent to around 700,000 "missing" workers.
"Much of the decline in labor force participation over the past three years should have been anticipated even absent the pandemic," Katharine Abraham, a University of Maryland economics professor and former U.S. Bureau of Labor Statistics commissioner, and Lea Rendell, a University of Maryland doctoral candidate, wrote in a study released late on Wednesday in conjunction with a conference at the Brookings Institution think tank.
These demographic factors make it unlikely the unemployment rate can get much lower than 3.5%. That constraint matters because Biden's "Go Big" stimulus plan has made the economy "inefficiently tight", which aligns with Krugman's mid-2022 observation the economy is "running hotter than numbers like G.D.P. or the unemployment rate suggest":
A new independent economic analysis helps to show why the low unemployment rate has yet to resonate with people: There aren’t enough workers to fill the open jobs, causing the economy to operate with speed bumps and frictions that make things seem worse than they are in the data. The analysis suggests that the economy would arguably function far more smoothly with unemployment higher at 4.6%, even though that could translate into nearly 2 million fewer people holding jobs.
The job market is what economists call “inefficiently tight,” a problem the United States also faced during the Vietnam War, the Korean War and World War II. The current tightness is as severe as it was at the end of World War II. This mismatch causes companies and consumers alike to feel as though the economy is in a rut, said Pascal Michaillat, an economist at Brown University.
Not in a rut, so much as failing to deliver on its promise by making everything both more costly and more scarce than the economy can either afford or sustain. In the now immortal words of Larry Summers, President Biden's "excessive stimulus driven by political considerations was a consequential policy error". Then again, Larry Summers is in the enviable position of being able to say "I told you so!"
But the activists who pushed the "Go Big" stimulus thought they knew better. Looking in the rear view mirror, it's amazing to learn how much they didn't know but should have. It's also rather amazing to consider what they knew but chose to disregard in dismissing the warnings of mainstream economists. Their legacy will make for quite a cautionary tale.
Katharine Abraham and Lea Rendell. Where are the missing workers? Brookings Institution. [PDF Document]. 30 March 2023.
Lauren Bauer, Wendy Edelberg, Sara Estep, and Brad Hershbeln. Who's missing from the post-pandemic labor force? Brookings Institution. [Online Article]. 4 April 2023.
Stephanie Ferguson. Understanding America's Labor Shortage. U.S. Chamber of Commerce. [Online Article]. 7 April 2023.
Paul Krugman. I Was Wrong About Inflation. New York Times. [Online Article]. 21 July 2022.
Pascal Michaillat. US Labor Market Continues to Cool in March But Remains Inefficiently Tight. Pascal's Newsletter. [Online Article]. 7 April 2023.
Political Calculations. How Bidenflation Was Made. [Online Article]. 30 March 2023.
Image credit: Photo by Brett Jordan on Unsplash.