- Republicans argue that Biden’s stimulus plan will fuel inflation. Wall Street is not that concerned.
- Economists at the big banks see that new aid only modestly increases inflation while supporting the US recovery.
- This is how UBS, BofA, Goldman Sachs and Deutsche Bank see stimulus measures affecting inflation in 2021 and beyond.
- Visit Insider’s Business section for more stories.
The debate about passing President Joe Biden’s $ 1.9 trillion bailout proposal is straightforward.
Democrats argue that the hole in the economy is so wide that it is justified to spend nearly $ 2 trillion, on top of the $ 3 trillion spent last March and the $ 900 billion spent late in Trump’s term. Republicans point to all the relief the government has already provided, saying the economy could recover with a much smaller boost. If you overdo it, they say, spending so much inflation can lead to worrying levels.
But there’s a third player in the debate: Wall Street’s investment banks cracking the math. And they are increasingly saying that concerns about runaway inflation are misplaced.
For weeks, economists had sat on the sidelines of major banks, vaguely saying that another package would achieve its intended goal of accelerating growth. With Democrats pushing ahead with Biden’s grand-scale plan and likely to approve the bill in mid-March, the Wall Street takeover is unlikely to make Republicans too happy.
Every major bank has its own forecasts, models, and team of experienced economists, and many come to the same conclusion: The benefits of the Biden Plan overshadow the risks. After a decade of weak inflation and a currently stagnating economic recovery, Wall Street applauds efforts to boost the economy with a massive shot in the arm.
Here’s what four banks have to say about new stimulus measures and what their inflation could be.
(Spoiler: not very much)
Bank of America: ‘A difficult balance, but very successful so far’
Investors haven’t been alarmed by inflationary concerns about stimulus packages. Stocks – which have sold out in the past when consumer prices were overheated – are near record highs. Investors also continue to move to oppressed companies that will recover as the economy reopens, indicating that they are more focused on earnings growth than potential inflation headwinds.
Michelle Meyer, the head of US economics at Bank of America, puts it succinctly: the market “paints a story of optimism.”
“Market participants are looking for stronger economic growth to boost inflation, but not to tighten the Fed too quickly,” the team said in a note on Friday. “It’s a difficult balance, but very successful so far.”
The company forecasts gross domestic product growth of 6% in 2021 and another 4.5% next year. This kind of expansion would fill the hole in the economy by the end of 2022, and additional stimulus measures would further accelerate growth, the economists said.
The question is not whether the economy will overheat, but how much they added. The output gap – the difference between actual GDP and maximum potential GDP – is expected to reach its largest surplus since 1973, according to the bank, if Biden approves his proposal.
But with the Federal Reserve actively pursuing inflation above 2%, the hole in the economy will likely need to be filled before there is a return to stable growth, the note said.
UBS: ‘Only rising gradually’
The White House package may exceed what’s needed, but the impact on inflation “will likely be small,” UBS economists led by Alan Detmeister said in a Wednesday letter to customers.
According to the bank’s rough estimate, the proposal will lead to about 0.5 point more inflation compared to a scenario where no additional aid is approved.
Price growth is expected to rise “only gradually” after “modest” inflation in the first half of 2021, the team said. Core spending on personal consumption – the Fed’s preferred inflation indicator – will rise to 1.8% in 2022 and to 1.9% the following year, still below the central bank’s target. Inflation is likely to exceed 2% after 2023 if the economy can continue to pick up, UBS said.
The forecast does not yet take into account the currently proposed stimulus measure, but the package “poses a small upside risk” and is unlikely to lead to inflation of 2% sooner, the economists added.
Goldman Sachs: ‘Models currently underestimate the slack’
Economists led by Jan Hatzius took a different approach and focused on models measuring the output gap rather than inflation expectations. The statistic depends on the maximum potential GDP estimates published by the Congressional Budget Office, but those estimates change over time as the U.S. economy evolves.
History suggests the CBO’s calculations are flawed and “currently low slack” in the US economy, Goldman economists said Wednesday. The team claimed that the firm’s model suffers from endpoint bias, meaning it interprets short-term changes as reversing a long-term trend.
According to the bank, economists do not have to look far back to find other examples. The CBO’s estimate of potential GDP was revised consistently lower from 2009 to 2017 when actual GDP fell short of the maximum potential. The revisions then turned positive in 2018, when actual GDP exceeded the estimated maximum. The CBO reinterpreted what appeared to be overheating at first only to catch up to its full potential later, the economists said.
“On the way down as well as on the way up, actual GDP was therefore a leading indicator of estimated potential GDP, indicative of endpoint bias,” they added.
Overall, Goldman expects the output gap to currently be more than twice the CBO’s estimate, supporting the bank’s view that “inflation risk remains contained,” even with its growth estimates above consensus. The CBO’s model is also hard to reconcile with inflation over the past decade, Goldman said, as price growth steadily lags behind the Fed’s target even as the budget keeper watched the economy overheat.
Deutsche Bank: ‘An unusual moment in macro history’
A special report on Friday by Alan Ruskin, Deutsche Bank’s Chief International Strategist, attempted to strike a balance. In essence, he wrote, the next year will be too early to tell.
Ruskin noted that inflation typically tends to lag growth by as much as two years, writing that fears of inflation are unlikely to be easily proven right or wrong in 2021.
“A few soft US inflation data will not sound completely clear. However, a few strong US inflation data will be a cause for concern,” he wrote. “There is then an inherent asymmetric skew in how markets will think about inflation risks in the future.”
Ruskin foresaw inflation fears for this reason, as being ‘fully clear’ about inflation risk will not be feasible. In the medium term, he added, “the” market implications of meaningful acceleration in US inflation are much greater than if inflation does not accelerate. “
Zooming out a bit, Ruskin noted that this is ‘an unusual moment in macro history’ where ‘the’ stars ‘align in relation to inflation fears’ because economists of different traditions, ranging from neo-Keynesians to monetarists to the Austrian school, all have growing evidence showing more rather than less inflation risk.
These elements include the fastest growth in the money supply in history; the strongest expected real growth in 70 years; closing a large negative output gap and some of the most accommodative financial conditions ever recorded.
Ruskin wrote, “There is a certain sense of ‘if not now, when?’ ”