Janet Yellen Misunderstands Inflation

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US Treasury Secretary Janet Yellen

San Francisco / June 6, 2021

Many people including this writer have criticized the Biden Administration's proposed $4 trillion spending plan. The Biden Administration says we are in a "low inflation" economy where the traditional relationship between higher government spending and higher inflation will not hold. This is a core assumption in Biden's economic strategy.

I claim we are now seeing signs of inflation and there will be more inflation if Biden proceeds with his plan (link). In an interview at the G7 meeting in London today, Treasury Secretary Yellen responded to this criticism:

"If we ended up with a slightly higher interest rate environment it would actually be a plus for society’s point of view and the Fed’s point of view. ... We’ve been fighting inflation that’s too low and interest rates that are too low now for a decade,” the former Federal Reserve chair said, adding that “we want them to go back to” a normal interest rate environment, “and if this helps a little bit to alleviate things then that’s not a bad thing -- that’s a good thing.”

Respectfully, Yellen is confused. If the US government wants to fight inflation that is "too low" and interest rates that are "too low", the Federal Reserve should raise the interest rate. That is a mechanical lever that Fed Chair Jerome Powell can pull. Attempting to trigger inflation through fiscal stimulus is risky. It is very difficult to predict inflation and then reduce inflation if it gets too high. Large fiscal stimulus by the Johnson Administration in the 1960s caused inflation that stunted economic growth for Americans at all income levels.

Mainstream economists say 2% inflation is healthy for the US economy. Some consumer price indicators are showing 4% year-over-year inflation now (link). Any inflation above 2% is harmful. It reduces the purchasing power of the dollar, and that causes more marginal harm to lower income households. President Biden keeps saying he wants to help the working class. If he wants to help the working class, his Administration should not trigger inflation above 2%.

It takes more skill for any government to create useful outcomes on a lower budget. The Biden Administration must be more selective on how it spends money. If Biden proceeds with the present spending plan, he will harm the lower income households that liberals want to help.

Also, the Biden Administration should allocate more funding to UBI initiatives, not government programs that imagine they will create jobs. The US government is not good at predicting how spending will translate to job creation. In contrast, universal basic income is a direct way to put money into the hands of households where the marginal dollar has more impact.