Life: $3.5tn US spending and inflation, what to expect?

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The $3.5tn price tag on the Biden administration’s budget plan has ignited fresh debate in Washington about the potential inflationary effects of increased public spending at a time when US consumer prices are rising rapidly.

The US senate passed a budget resolution that will form the basis of a sweeping bill that would make big investments in education, housing and climate-related initiatives, expand Medicare and enhance a child tax credit programme, among other outlays.

The legislative blueprint includes a mechanism to offset the spending with higher taxes on US companies and wealthy Americans. It was passed on the heels of a bipartisan $1tn infrastructure bill and was quickly followed by the latest inflation report, which showed prices were steady in July at a 13-year high, despite a more moderate monthly increase and a significant drop-off in gains for some of the most pandemic-sensitive sections.

Rising inflation fears could imperil Joe Biden’s spending ambitions as the two bills head to the House of Representatives later this month. The House, which Democrats control by a slim margin, will return from summer recess early to first consider the budget resolution, and then weigh up the infrastructure package. Both pieces of legislation must pass both chambers of Congress. 

While the infrastructure bill passed the Senate with bipartisan support – 19 Republicans, including Senate minority leader Mitch McConnell, voted for the legislation – Democrats have elected to go it alone with the budget process, using a convention called reconciliation to get around the 60-vote filibuster threshold in the Senate. The budget resolution passed the upper chamber in a party-line vote, with all 50 Democrats voting for the measure and 49 Republicans voting against.

Although facing criticism from both Democrats and Republican parties, Biden has staunchly rejected those claims noting this week the sharp deceleration in price gains for “core” inflation, which strips out volatile items like food and energy, and for items like used cars and other travel-related expenses, whose previous increases have contributed significantly to this year’s inflation surge.

He also made the case that the investments included in the budget bill would help to counterbalance rising costs for essentials like housing, food, and healthcare, reiterating an argument laid out by economists at the Council of Economic Advisers and the Office of Management and Budget this month.

The administration’s stance has won the backing of many Wall Street economists and investors, who broadly subscribe to the view that inflation jitters tied to the new spending bill are overblown.

Market measures of inflation expectations also reflect this outlook. The 10=year break-even rate, which is a popular proxy for future inflation and is derived from prices of US inflation-protected government securities, has steadied around 2.4 per cent, having peaked in May near 2.6 per cent.

One main stream opinion is that the plan’s 10-year time horizon limits its immediate economic impact. The $3.5tn is not happening in the following year, but spread out in the coming 10 years time. And this should soften its impact on inflation.


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