Democrats in the U.S. Senate have chosen to move forward with the next pandemic relief package using reconciliation – the arcane process that allows certain bills to circumvent the filibuster rules and pass with only 50 votes, not the typical 60. In light of this, we have increased our estimate of the final size of the fiscal package to a range of $1.5 trillion to $1.9 trillion (likely closer to the higher end of that range). This means we’ve also increased our U.S. growth forecasts for 2021.
The use of reconciliation means that it is no longer a question of which provisions may garner some Republican votes, but more what type of package can keep all 50 Democrats united in the Senate. Even though there may be some tweaks to Biden’s original proposal, there seems to be broad unanimity among Democrats that going big, simple, and fast is the best approach. As a result, we expect a package to pass and be signed into law by mid-March, if not sooner.
The additional COVID-19 relief, on top of the $900 billion package from late last year, could boost the 2021 federal government deficit to over $3.5 trillion – an unprecedented level – and contribute to 2021 real GDP growth of over 7% (as we discussed in this January 2021 blog post). For context, reported fourth-quarter-over-fourth-quarter real GDP growth has only been above 7% three times since 1950, and each of those instances occurred either before or during the great inflationary episode of the 1970s–1980s. At the same time, the Federal Reserve is likely to be more accommodative of the additional spending and has committed to allowing inflation to run above its long-term 2% target.
In this context, it’s not surprising that more investors are worried about another inflationary accident. While a period of above-target inflation has become more likely, in our view, the likelihood of a self-reinforcing inflationary process similar to what happened in the 1970s is still relatively low. If monetary and fiscal policies remain expansionary for several years after economies return to full employment, then inflation could exceed central banks’ targets eventually. But as noted in PIMCO’s most recent Secular Outlook, we are monitoring risks for both longer-term inflation and deflation.
What is likely to be included in the pandemic relief bill?
We expect the final package to include much of what President Biden has proposed:
- $1,400 stimulus checks to individuals under a certain income threshold, which is being debated
- Several tax provisions, including a child tax benefit that would be paid monthly (the current proposal is $3,600 per year for children under the age of 6 and $3,000 for ages 6–17)
- Funding for states and cities ($350 billion total is currently proposed)
- $160 billion for vaccine distribution
- An expansion of federal unemployment insurance from $300 to $400 per week extended through the end of September 2021
- Homeowner assistance
- Aid for small businesses and certain affected industries (e.g., airlines)
- Other provisions, such as additional support for paid leave and nutrition programs
What likely won’t be included?
We do not expect the proposed increase in the federal minimum wage to $15 per hour to be included. The Senate reconciliation rules may prohibit such a provision from qualifying (under the so-called Byrd Rule), and – perhaps more importantly – there may not be 50 Democratic votes in the Senate for a minimum wage increase. Senator Joe Manchin has pushed back on it, and our view is that some other moderate Democratic senators also may not support it.
A return of 1960s-style U.S. growth …
As a result of our upgraded fiscal stimulus outlook, we have also upgraded our outlook for U.S. economic activity. We now expect real GDP to grow in a range of 7%–7.5% in 2021 (fourth-quarter-over-fourth-quarter) – levels not seen since the early 1980s and, before that, the mid-1960s. Of course, the economic effects of the new fiscal package will depend on the final details. But based on what we now know, the legislation’s focus on enhancing automatic stabilizers and social safety net programs – including additional unemployment benefits, paid leave, and supplemental nutrition provisions – coupled with the direct support to households, businesses, and state and local governments not only boosts the near-term growth outlook but also may help mitigate downside risks, including a slower-than-expected vaccination program.
… may not lead to 1970s-style inflation
Our upgraded growth expectations imply a faster decline in the unemployment rate, but because the relationship between labor market slack and inflation – the Phillips curve – is relatively flat, this doesn’t have huge implications for our inflation outlook. We expect U.S. core CPI inflation to end 2021 around 1.5% year-over-year, after temporarily accelerating to 2% (annualized) over the next several months. Looking further out, we forecast annualized core CPI to only gradually accelerate up to a range of 2.2%–2.5% over the course of the next several years.
And while the outlook for fresh government support reinforces our view that inflation will likely exceed the central bank’s target, we still view the longer-term inflationary risks as balanced. Indeed, if monetary and fiscal policies remain expansionary for several years after economies return to full employment, then inflation could exceed central banks’ targets eventually. However, fiscal fatigue is also a possibility, and structural changes in labor markets since the 1970s limit the likelihood of a self-reinforcing inflationary acceleration.
Structural changes in labor markets still matter
Since the 1970s, structural changes in the U.S. economy have worked to reduce labor bargaining power, and help explain why firms generally don’t increase wages even when labor markets are tight and job vacancies are hard to fill.
Some of these changes include a decrease in the number of establishments per industry that compete for workers; a proliferation in right-to-work laws, which have contributed to lower union membership; the increased use of noncompete contracts and anti-poaching agreements; the rise of the gig economy; and state laws that allow potential employers to demand salary history.
And although the Biden administration’s pro-labor policy agenda is focused on reversing these trends, the reality is likely to change only slowly over time. So while it’s possible that the U.S. could have an inflation scare, whereby supply or even demand shocks result in what could be multiyear price level adjustments, it is likely going to take a number of years of a hot labor market to reverse the 40-plus-year trend toward lower labor bargaining power. Until then, longer-term inflationary risks appear balanced.
For more on PIMCO’s outlook for the economy and markets, including investment implications, please watch the latest View From the Investment Committee video, “Preparing Portfolios for Recovery and Growth.”
Libby Cantrill is head of public policy and Tiffany Wilding is an economist focused on North America. They are regular contributors to the PIMCO Blog.