“The significant fiscal stimulus in the United States, along with faster vaccination, could boost US GDP growth by over 3 percentage points this year, with welcome demand spillovers in key trading partners.” (OECD, March 2021)

“Financial markets are signaling that they expect a return to underperformance once the Biden boom is behind us. These days interest rates are, in effect, a barometer of economic optimism — and these rates have in fact risen as the rescue plan has moved toward the finish line. But the rise has been modest, comparable to the “taper tantrum” of 2013 and minor compared with some interest rate surges of the 1990s.” (Paul Krugman, NYT, March 9, 2021)

There is little doubt that the US economic outlook is brightening, and that unwarranted fears of inflation are also coming back. 

However, the bottom line is that a sustained increase in US inflation is unlikely because the economy is expected to operate substantially below potential for a number of years.

Renewed economic growth optimism is based on the apparently successful rollout of a series of coronavirus vaccines and on the unprecedented amount of fiscal stimulus ($1.9 trillion or about 8½% of GDP) provided by the Biden Administration.

As well, there is also the massive amount of monetary stimulation provided by the Federal Reserve System, with promises that money will be incredibly easy well into 2023. 

One of the clear consequences of all of this is that the US economy is expected to project the appearance of very steep growth rates this year and into 2022. But this is rebound growth, not quite the kind of growth associated with a normal recovery.

However, the expectation of rapid rebound growth over the next couple of years has become the accepted consensus among economic forecasters. I will comment on two sets of US economic projections - the CBO’s and the OECD’s. 

As of February, the CBO’s benchmark projections had the US economy recovering 4.6% this year after shrinking 3.5% in 2020. The economy was then projected to average a 2.3% annual growth rate until 2025, and then slip lower to a 1.7% annual growth rate between 2026 and 2031. 

Although this year’s growth estimate seems a bit to low, nonetheless the CBO concludes that the US economy would return to its pre pandemic level by mid-2021 and then expand at its maximum sustainable level into early 2025. 

In CBO’s projections, the unemployment rate gradually declines through to 2026, and the number of people employed returns to its pre pandemic level by 2024. 

As for the more optimistic OECD projections, the combination of the huge fiscal stimulus this year and near zero interest rates spurs the US economy into rebounding, but at a faster pace, 6.5% this year and then 4% in 2022. 

Of course, the apparently strong economic rebounds this year and in 2022 is behind much of the euphoria in equity markets. That is, the projected stronger nominal GDP growth this year should support some of the elation about improving corporate earnings which underpins stock market euphoria.

What seems to be missing in this wave of growth euphoria is that even after the pandemic subsides there will still be a number of real economic problems left behind. 

Of course, there is always the bogey of too much fiscal stimulus and high government deficits to deal with.

The revival of stronger economic growth also brings with it the possibility of rising inflation, which in the future could prompt the Federal Reserve to raise interest rates.

As matters currently stand, however, since March of 2020 when the Fed cut interest rates to near zero, the US central bank signaled on many occasions that it would not worry about inflation and that it would hold interest rates extremely low until the end of 2023. 

Indeed, when the US economy shrunk massively last year, easy money provided a massive tailwind to equity prices and housing prices.

My own view is that the fear of inflation has become a greater threat to the American economy and equity markets than inflation itself. 

Markets seen unwilling to fully accept that we are currently trapped in an environment of anemic inflation. For example, just consider the CBO’s ten-year inflation projections which average only 2%.

In terms of the Republican criticism of Biden’s $1.9 trillion fiscal injection, the concerns about its inflationary potential is based on an argument that the fiscal stimulus is larger that the output gap. 

While it clear that US real GDP growth will exceed estimates of maximum potential growth over the next several years, nonetheless the output gap is still projected to remain substantial until about 2025.

In CBO’s projections, the annual growth of real (inflation-adjusted) GDP exceeds that of real potential GDP until 2026 and then falls below the trend pace. 

In other words, the gap between actual and potential GDP is likely to remain quite large all the way until 2025, before falling back.