Stimulus money is partly behind soaring U.S. inflation, Fed study finds

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The early days of the pandemic were among the darkest economic moments in recent history for low-income Americans struggling with unemployment and lost incomes. The Trump administration quickly provided relief by signing a $2 trillion package in March 2020 that sent $1,200 checks to every American who earned less than $75,000 along with enhanced unemployment, and forgivable business loans. President Joe Biden followed with additional stimulus money. 

In total, American households received more than 472 million pandemic relief payments worth $803 billion. In total, nearly $5 trillion went to households, businesses, local governments, and other institutions.

And the programs worked, at least as far as their intended purpose. “Material hardship in U.S. households fell sharply” as a result of the payments, a 2021 Census Bureau survey found, including for problems like malnutrition, mental health, and financial instability.

For months, partisan debates have raged over whether the early pandemic stimulus fueled the past year’s high inflation, or if high prices were caused by other factors like China’s COVID lockdowns tangling supply chains

The answer, according to a new study by the St. Louis Fed, is that government stimulus was indeed responsible for some U.S. inflation. The authors found that 2.6 percentage points of the 7.9% 12-month inflation rate in February 2022 was due to stimulus.

The authors found that stimulus payments led to substantially more demand for goods in the run up to 2022, but industrial production at the time was unable to keep up. The result was a higher amount of “excess inflation,” they said.  

By narrowing the study to February 2022, the authors excluded any analysis of more recent inflation rates. It also happened to largely miss the impact of Russia’s invasion of Ukraine on Feb. 24, which caused energy and food prices to soar.

An economic lifeline

While white collar American workers retreated to their laptops and home offices to work remotely in 2020, many other Americans weren’t as lucky. Unemployment surged in the first half of 2020 and permanent business closures piled up. The number of people living below the poverty line ticked upwards, and more than half of Americans expected to run out of savings before the year closed out.

The wave of stimulus payments were an essential lifeline for low- and moderate-income Americans whose livelihoods were hit hardest by the pandemic, and may have helped lift nearly 12 million people out of poverty in 2020 alone, according to the Census Bureau. Meanwhile, federal stimulus to businesses amounted to $1.7 trillion throughout the pandemic

But while more than half of Americans reported using their stimulus money to pay for basic necessities including food and rent, recipients with higher incomes tended to save it. Consumer spending soared in 2021 due to greater disposable income. But with fears of COVID transmission and travel restrictions worldwide still in place, that spending was overwhelmingly on goods rather than services, contributing to the market imbalances that lifted the inflation rate in February 2022.

While stimulus checks helped keep consumption at relatively strong levels even during lockdowns, industrial and manufacturing activity did not accelerate to keep pace, the Fed study’s authors wrote.  

“By stimulating demand without boosting supply, our results suggest that fiscal support contributed to increased excess demand pressures in goods markets,” they added.

The findings of the research align with another study from the Federal Reserve Bank of San Francisco in December that also identified short-term inflationary effects linked to fiscal stimulus in 2020 and 2021. The latter study found that stimulus issued directly to consumers was more inflationary than stimulus for businesses.

The St. Louis Fed survey also suggested that higher-than-expected consumer spending and supply chain issues may have amplified each other to feed rising inflation.

“This policy was successful at boosting consumption, which, together with a relatively inelastic supply, may have led to supply chain bottlenecks and price tensions,” the authors wrote. 

However, the Fed’s St. Louis and San Francisco studies both noted that the social benefits of stimulus payments could potentially outweigh the negatives of inflation.

“One should also recognize the positive role played by generous government support throughout this unprecedented crisis. The large spending supported a strong economic rebound, with both GDP and employment recovering at a remarkable pace, likely preventing worse outcomes despite the price pressures that may have resulted from the spending,” the St. Louis authors wrote.

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