Will the Stimulus Work? Watch These 3 Metrics

President Joe Biden’s $1.9 trillion relief and stimulus bill sets the U.S. off on a great economic experiment.

It will test how much fiscal stimulus the U.S. economy can absorb after a year of pandemic anxiety, social distancing and lockdowns, when households are sitting on a pile of cash that they are eager to spend while seeing friends and family, and with output rising and unemployment falling.

The policy debate about Biden’s plans has been surprisingly high quality, with supporters and critics alike offering solid arguments for and against the threat of damaging inflation and the likelihood of a solid and sustained recovery. It’s not surprising that economists disagree, given the massive uncertainty about the economy’s performance in the coming year.

I have been a critic, voicing concerns about inflation even before Biden took office. How will we know which side of this debate was right? I’ll be paying particular attention to three metrics:

  • Inflation expectations. Investors now expect prices to rise by an average of 2.5% over the next five years. If they’re right, that would be a policy victory. But if their expectations climb to 3%, my concern about the possibility of damaging runaway inflation will grow. And if it crosses 3% and stays above it, I would expect the Fed to attempt to slow the recovery. Unfortunately, the conditions for this to happen are ripe. The economy will be running very hot in 2021, with demand growing faster than supply can keep up. The Federal Reserve has adopted a blasé attitude about future inflation. And Congress seems remarkably unconcerned about the dangers of deficit spending, and is already talking about spending trillions more this year. If the fiscal and monetary authorities are unconcerned about inflation, markets might expect more of it. It is useful to interpret market expectations about the next five years in light of the inflation outlook for the following half-decade. This metric is also elevated. But it is much lower than the five-year expectation, standing at a bit above 2%. Taken together, the story is clear: Investors expect prices to grow more rapidly than the Fed’s target over the next five years (2.5%), but in the five years after that, they expect a return to the Fed’s 2% goal. This is a Goldilocks situation.
  • Monthly payroll employment gains. The economy was down 9.5 million payroll jobs last month relative to February 2020, the month before the pandemic began. The economy won’t have fully healed from the pandemic until all those jobs are back. If things go right, the economy will be back to full employment around the end of 2022, adding around 500,000 net new jobs each month. But there’s a risk that the jobs boom will be too front-loaded, if virus-sensitive industries like leisure and hospitality aggressively spring back to life in the next six months. And there is the risk that the generous unemployment benefits in Biden’s stimulus hold the labor market recovery back. The rule of thumb I’ll be using is whether monthly gains are above or below 500,000. If the economy consistently adds, say, 1 million jobs per month, then I’ll be worried about demand-side overheating. If the economy regularly adds around 250,000 jobs per month, I’ll be worried about unemployment benefits holding back the supply side of the economy in the face of rapid demand. I’ll also be interpreting data on job gains in light of inflation expectations. If the economy can add 1 million jobs per month without expectations climbing, then the Biden stimulus will be succeeding.
  • Inflation. There are many measures of inflation, but I’ll be paying especially close attention to the price index for personal consumption expenditures, excluding the volatile food and energy categories. That measure — called “core PCE” — hasn’t been above the Fed’s 2% target since December 2018, and in January clocked in at 1.5%. Though it is the Fed’s preferred measure of inflation, it gets less attention than the Consumer Price Index. And the CPI typically registers faster price growth than the core PCE. On top of that, oil prices will push up the CPI, but won’t affect core PCE. This will add to the Fed’s already considerable communications challenges. It will be a policy victory if core PCE hits 2.5%. But a month here or a month there of eye-popping inflation — in the 4% or 5% range — will make me nervous that the Fed will act to slow the recovery.

I’ll be looking at lots of other measures, too. Long-term unemployment has enormous costs to workers, so reducing its ranks is a top priority. The length of the average workweek is a good indicator of whether businesses are ramping up output and seeing increases in demand for their products and services. The unemployment rate is the single best statistic to determine how much slack is in the labor market. The yield on 10-year Treasury bonds indicates investors’ views on the economy’s prospects for growth. The rate of workforce participation will tell whether workers who have left the labor market due to the pandemic are returning.

The president’s experiment could be a big success, rapidly getting millions of workers back into jobs instead of making them wait a few more years for a full pandemic recovery. It also could end poorly, with inflation taking off or the Fed slowing the economy out of concern about consumer price increases and frothy financial markets.

These indicators will help tell the story of the most ambitious — or reckless — fiscal policy decision in living memory.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and Arthur F. Burns Scholar in Political Economy at the American Enterprise Institute. He is the author of “The American Dream Is Not Dead: (But Populism Could Kill It).”

©2021 Bloomberg L.P.

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