The Federal Reserve’s response to COVID-19 (3/4)

It could be argued that the US has not gone far enough to address the economic impacts of the pandemic. Joe Biden’s stimulus package could have an adverse effect on potentially triggering a different issue of demand-pull inflation which could cause stagflation.

This form of inflation derives from an outward shift of Aggregate Demand causing market equilibrium to be met at a higher price level. This increase in the price level can lead to inflation which, if goes unchecked could have many disastrous impacts. Inflation could occur due to the output gap being estimated at roughly a 1/3rd of the value of the package which could potentially cause an excessive increase in spending.

Due to low-interest rates, as previously mentioned, combined with the $1400 given to eligible US citizens, consumption could massively increase which would cause a triggering of inflation. A consequence of this would be a deterioration in living standards due to a fall in the value of US savings. An earlier indication of this potential risk can be demonstrated through inflation data which evidences a rise from 2.24% in 2020 to 0.62% in 2021.

This is also backed up by Consumer Price Index (CPI) data, which measures inflation by surveying the rate at which the prices of goods and services consumed by households rise or fall. CPI in 2021 is at 266.71, by 2025 it is projected to rise to 290.4 from the base year of 1982, which would be the highest since records began.

This is significant in illustrating that prices will rise proving that demand-pull inflation is a growing dilemma caused by the enormous stimulus package, which is 3 times larger than the output gap created by the lack of activity during the pandemic. Therefore signalling that the FED may have been excessively focussed on an immediate revival of the economy without identifying the potential long term implications of this stimulus package.