Forecasting Inflation: What May Happen Next?

The Biden administration has been governing the United States of America since January 20, 2021. Since February 2021, the U.S. inflation has been increasing considerably. According to the U.S. Bureau of Labor Statistics, inflation increased from 1.40% in January 2021 to 5% in May 2021. However, over the last twenty years, inflation has been maintained at the creeping level where prices were overall stable at the 2% rule.

Figure 1. Source: U.S. Bureau of Labor Statistics

I – Biden Economic Policy

If inflation has been relatively stable for the past twenty years, why did it drastically increase under the Biden Administration? Well, the Biden economic policy is a direct appeal to more government spending. Biden economic policy consists of implementing the American Rescue Plan, which costs $1.9 trillion (this bill was singed into law in March 2021), the American Job Plan, a $2.65 trillion infrastructure bill that has not yet been signed into law, but it is in the process of soon becoming law; the American Families Plan, another bill proposed by President Biden to reduce poverty, and so… The list is long, all of his proposals of economic policy cannot be listed but all of them will only increase taxes on the American taxpayer. More importantly yet worrisome is the tax plan that President Biden aim to implement if it was approved by Congress.

The tax policy proposed by President Biden will increase inflation, which will do more harm to the middle and working-class American families.[1] According to the findings of the Tax Policy Center, a nonpartisan think tank based in Washington, D.C., most of Biden’s proposed tax increases would be paid by those earning more than $800,000 annually, three-quarter of household earning between $75,000 and $100,000 would pay an additional $440 per year according to the data.[2] At the same time, about 69% of those earning between $100,000 and $200,000 would see their tax bill rise by $830 on average, while 83.7% of those earning between $200,000 and $500,000 would see an increase of $2,040 on average.[3] This tax hikes, will increase government spending, and more government spending will increase the costs of production, and this cost of production will ineluctably trigger more inflation.

II – The Impact of CPI on Inflation

In the meantime, the price of commodities has increased since the end of last year. Food prices are up 3.5%, with meat and eggs by over 5%.[4] The price of gasoline has dramatically increased by 22% over the last couple of months, Used cars and trucks were 7% more expensive in May than in April which saw a historical 10% increase month over month,[5] and the cost of eating out increased by 3.7% over the past year as well.[6] Overall, the consumer price index (CPI) has increased as a result of a supply shock. We are currently dealing with a kind of cost-push inflation as we can see in this figure.

Figure 2

III – Forecasting Inflation and the potential aftermath

Under the Biden administration, it is clear that government spending is going to substantially increase. It was announced in late May 2021 that President Biden will propose $5 trillion in new federal spending over the next decade as part of his fiscal year 2022 budget request.[7] I decided to forecast the inflation rate for the next three months (if we consider the month of June done) to see where we will be by using the autoregressive model. The data used to forecast inflation rate was based on the U.S. Bureau of Labor Statistics and Inflationdata.com where (n = 30). The data starts from the January 2019 and goes all the way to May 2021. The months forecasted are June[8], July, August, and September.

Figure 3. Source: Author’s computation

The results of the model suggest that inflation may potentially increase to 6.67% by September 2021. The 6.67% is a rough estimation. It does not mean that inflation will necessarily be 6.67% by that time. This increase in inflation would be due to an increase in government spending from the Biden administration for the most part. Moreover, if the consumer price index continues to increase through the cost-push inflationary model, inflation will continue to increase which will eventually slow growth.

In order to reduce inflation, two forms of policies could be implemented. (1) the Federal Reserve could increase short-term interest rates in order to attenuate inflation. The data show that short-term interest rates have neared the 0.0% as we could see in figure 4. In doing so, it will be hard to borrow, and the expansion of credit will be reduced. (2) The implementation of supply-side policies would be urgently necessary to contain the growth of inflation. This recommendation would be harder to implement as soon as possible because supply-side policies are designed for long-term results. Nonetheless, I believe that it would be good to implement them now because they can be used to maintain inflation low in the long-run. Supply-side policies will increase long-term competitiveness and productivity through deregulation and privatization. Now I am wondering if President Biden would be willing to implement such policies knowing that his beliefs in demand-side economics are what encouraging him to expand government spending. Only time will tell. For my part, I remain skeptical that President Biden would want to deregulate the economy.

Figure 4. Source: OECD Data

References

[1] Tate, Kristin. “Growing Inflation is Biden’s Hidden Tax on Working Americans.” The Hill. (2021) [2] Henney, Megan. “Biden’s tax proposal means that 60% of Americans could pay more: Here’s how much” Fox Business. June 19, 2021. [3] Henney, (2021). Ibid. [4] Tate (2021). Ibid. [5] Tepper, Taylor. “Why Is Inflation Rising Right Now?” Forbes. (2021). [6] Henney, (2021). Ibid. [7] Wilkie, Christina; Mui, Ylan. “Biden’s budget will include $ trillion in new federal spending over the next decade” CNBC. (2021). [8] The inflation rate for the month of June has not yet been provided.