Both Manchin and Biden Are Wrong About Build Back Better’s Inflation Impact

Start with Mr. Manchin. For months he has cited concern about inflation and the federal deficit as reasons for his opposition to Build Back Better.

At The Wall Street Journal’s CEO Council earlier this month, he criticized economists, including 17 Nobel laureates, for saying this year’s rise in inflation would be transitory, when it hasn’t turned out that way. But this year’s inflation has nothing to do with Build Back Better. It’s possible that prior stimulus—in particular Mr. Biden’s $1.9 trillion “American Rescue Plan” pandemic assistance legislation, enacted in March—did contribute to this year’s inflation. But the 17 Nobel laureates never addressed that.

Even the American Rescue Plan’s contribution to this year’s inflation is debatable. Critics like Larry Summers, a former adviser to Democratic presidents, said it would help push total spending past the economy’s potential to supply goods and services, fueling higher inflation.

Yet that cannot explain why inflation has shot to 6.8%, a 39-year high, from around 2% right before the pandemic. Even after enacting the American Rescue Plan, the U.S. economy is only operating at around potential. Rather, as I’ve previously written, this inflation results from stimulus-inflated demand interacting with supply constrained by bottlenecks and shortages, including for labor, due to Covid-19 and the unusual spending patterns it unleashed.

More important, the American Rescue Plan’s spending is going to be largely disbursed in two years. By contrast, Build Back Better spending would be spread over 10 years with its maximum impact on the deficit coming next year at about $155 billion or 0.6% of gross domestic product, primarily through an extension of the expanded child tax credit.

Yet defenders of Build Back Better including Mr. Biden imply it will lower inflation, often citing Moody’s Analytics. In fact, Moody’s shows inflation would be 0.2 percentage point higher in 2022 through 2024 with Build Back Better. The Penn Wharton Budget Model, also cited by the White House, sees inflation 0.1 to 0.2 point higher over the next two years.

Fiscal stimulus doesn’t usually spur inflation when unemployment is high because so many workers want jobs and firms have no pricing power. But Build Back Better’s deficits, while small relative to the American Rescue Plan, would come when the economy is around potential. Unemployment was 4.2% in November, lower than the Congressional Budget Office’s estimate of the natural rate of unemployment, below which upward pressure on wages and prices tends to build.

On Tuesday Mr. Biden warned that without Build Back Better, the economy wouldn’t grow, citing downgrades by Goldman Sachs and others. This is ironic since the plan’s supporters have long insisted the plan wasn’t intended to stimulate near-term demand and therefore it wouldn’t lift inflation.

Without Build Back Better, economic growth will likely be lower than otherwise, but not by meaningful amounts. Goldman Sachs sees growth at 2.4% next year without it, instead of 2.9% with it, while Morgan Stanley sees it at 4.6% instead of 4.9%; neither changed their inflation forecasts. Both still see the economy growing faster than its long-run trend and unemployment falling well below 4% next year.

Tightening labor markets are one reason Federal Reserve officials worry today’s high inflation will persist and they have penciled in three quarter-point rate increases next year.

White House officials turn to the 17 Nobel laureates, Moody’s and Penn Wharton to claim Build Back Better “eases inflationary pressures” in the long run. The wording is artful. What they mean is that provisions like increased access to child care, preschool and parental leave could boost women’s labor-force participation and children’s productivity in the long run. This means the economy could grow faster without generating inflation. These so-called supply-side effects, though, are uncertain. And other provisions, such as no longer requiring child tax credit recipients to work, cut in the other direction.

In any case, all this wouldn’t actually affect long-run inflation because the Fed would adjust interest rates to keep inflation at its 2% target. Indeed, Moody’s sees inflation the same in a decade, with or without the plan. Penn Wharton sees a slight dip in inflation, but attributes that not to the bill’s provisions but to their expiration slowing the economy.

Both sides are ignoring simple truths. In the near term, inflation’s path will largely depend on whether Covid-related bottlenecks and labor shortages ease or get worse because of the Omicron variant. In the long run, it depends on the Fed.

Mr. Biden didn’t launch Build Back Better with supply-side growth or inflation in mind, but to expand the social safety net—by more, it turns out, than Mr. Manchin is comfortable with. That’s what should determine the outcome of this legislation, not these secondary and largely trivial effects on inflation.

Write to Greg Ip at [email protected]