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- Republicans argue that Biden’s stimulus package will fuel runaway inflation. Wall Street is not that worried.
- Big bank economists see only new aid that slightly raises inflation while helping the US recovery.
- Here’s how UBS, BofA, Goldman Sachs and Deutsche Bank see a stimulus affecting inflation in 2021 and beyond.
- Visit Insider’s Business section for more stories.
The debate over whether to pass President Joe Biden’s $ 1.9 trillion aid proposal is straightforward.
Democrats say the hole in the economy is so big it justifies spending nearly $ 2 trillion, on top of the $ 3 trillion spent last March and the $ 900 billion spent at the end of the term. Trump. Republicans point out all the relief the government has already provided and say the economy can recover with a much less boost. If you overdo it, they say, spending so much could bring inflation to worrying levels.
But there is a third player in the debate: the Wall Street investment banks doing the math. And they increasingly say that concerns about soaring inflation are irrelevant.
For weeks, economists at the big banks had stood on the sidelines, vaguely claiming that another package would meet its intended goal of accelerating growth. Now that Democrats are moving forward with Biden’s large-scale plan and are likely to push it through 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 outweigh the risks. After a decade of low inflation and a currently stagnant economic recovery, Wall Street is pushing for efforts to supercharge the economy with a huge blow in the arm.
Here is what four banks have to say about the new stimulus measures and what inflation could result.
(Spoiler: not much)
Bank of America: “ A difficult balance, but so far very successful ”
Investors were not shaken by inflationary concerns surrounding the stimulus. Stocks – which historically sold when consumer prices overheated – are at all-time highs. Investors also continue to look to downtrodden companies that will rebound as the economy reopens, indicating that they are more focused on earnings growth than the potential headwinds of inflation.
Michelle Meyer, head of the US economy at Bank of America, puts it succinctly, saying the market “paints a story of optimism.”
“Market participants are looking for stronger economic growth to drive inflation up but not trigger Fed tightening too quickly,” the team said in a note Friday. “It’s a difficult balance, but so far very successful.”
The company forecasts gross domestic product growth of 6% in 2021 and 4.5% next year. This kind of expansion would fill the void in the economy by the end of 2022, and further stimulus would accelerate growth further, economists said.
The question is not whether the economy will overheat, but by how much, they added. The output gap – the difference between real GDP and maximum potential GDP – is expected to reach its largest surplus since 1973 if Biden passes his proposal, according to the bank.
Still, with the Federal Reserve actively pursuing inflation above 2% for a while, the hole in the economy likely needs to be excessively filled before there is a return to stable growth, the note said.
UBS: ‘Increase only gradually’
The White House package could go beyond what is needed, but the effect on inflation “is likely to be small,” UBS economists led by Alan Detmeister said on Wednesday in a note to clients.
According to the bank’s rough estimate, the proposal induces around 0.5 point more inflation compared to a scenario where no additional aid is approved.
Price growth is expected to increase “only gradually” after “modest” inflation in the first half of 2021, the team said. Basic personal consumption spending – the Fed’s preferred inflation indicator – will rise to 1.8% in 2022 and 1.9% the following year, still below the central bank’s target. Inflation is expected to exceed 2% beyond 2023 if the economy can strengthen further, UBS said.
The forecast does not yet take into account the currently proposed stimulus measure, but the package “poses a small risk to the upside” and is unlikely to lead to inflation reaching 2% sooner, economists added.
Goldman Sachs: ‘Models Currently Minimize Looseness’
Economists led by Jan Hatzius took a different approach, focusing on models measuring the output gap rather than inflation expectations. The measure depends on estimates of maximum potential GDP released 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 underestimate the leeway” of the US economy, Goldman economists said Wednesday. The team alleged that the office model suffers from endpoint bias, which means it interprets short-term changes as a reversal of a long-term trend.
Economists don’t need to look too far back for more examples of this, according to the bank. The CBO’s estimate of potential GDP was constantly revised downward between 2009 and 2017, when real GDP was below maximum potential. The revisions then turned positive in 2018, when real GDP exceeded the estimated maximum. The CBO reinterpreted what first appeared to be overheating and then caught up to full potential, economists said.
“Both falling and rising, real GDP was therefore a leading indicator of estimated potential GDP, indicative of an endpoint bias,” they added.
Overall, Goldman projects that the output gap is currently more than double the size of the CBO estimate, confirming the bank’s position that “inflation risk remains limited” even with its estimates. growth rates above consensus. The CBO’s model is also difficult to reconcile with inflation over the past decade, Goldman said, as price growth has consistently been below the Fed’s target even as the budget official saw the economy overheat.
Deutsche Bank: ‘An unusual moment in macroeconomic history’
A special report released on Friday by Deutsche Bank’s chief international strategist Alan Ruskin aimed to strike a balance. In essence, he writes, this coming year will be too early to tell.
Noting that inflation generally tends to stunt growth by two years, Ruskin wrote that inflation fears are unlikely to be easily proven or false in 2021.
“A few weak US inflation figures will not seem entirely clear. A few strong US inflation figures will increase concerns, however,” he wrote. “There is then an inherent asymmetric bias in how markets will think about inflation risks going forward.”
Ruskin predicted an increase in inflation fears for this reason, as his “all clear” inflation risk will not be reachable. In the medium term, he added, “the consequences on the market of a significant acceleration of US inflation are far greater than if inflation does not accelerate”.
Zooming in somewhat, Ruskin noted that this is an “unusual moment in macroeconomic history” where “the” stars “related to inflation fears have aligned” because economists of various traditions , from neo-Keynesians to monetarists to the Austrian school, all have growing evidence showing more risk of inflation than less.
These elements include the fastest growing money supply in history; the strongest real growth expected in 70 years; the closing of a large negative output gap and some of the most accommodating financial conditions on record.
Ruskin wrote: “There is some sense of” if not now then when? “”
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