What Build Back Better Would Mean for Inflation

Graph 1, Market Commentary, 12.15.21

12.15.2021: President Biden’s Build Back Better bill is on the ropes. The prospect of spending $2 trillion on pre-K childcare subsidies, climate change initiatives and expanded Obamacare subsidies has run into fierce opposition from critics who argue that the sweeping spending bill would fan inflation’s flames.  The latest Consumer Price Index (CPI) and Producer Price Index (PPI) are attention-getting. Consumer prices surged 6.8 per cent over the 12 months through November, according to the Bureau of Labor Statistics, representing the highest inflation reading in nearly 40 years. The PPI of finished goods spiked 13.3 per cent from a year earlier, representing its highest annual increase since 2010, the year record-keeping began.

The legislative clock is ticking. Democrats hope to pass the $2 trillion Build Back Better bill before year-end. The current extension of the child tax credit, the cornerstone of the program which provides as much as $300/month per child, expires at the end of the year. The IRS has informed lawmakers they would need to reauthorize it before December 28 to keep January payments on track. The political stakes are high. The White House understands the danger of failing to pass the sweeping social support system: President Biden, whose approval rating fell below 50 per cent in August and is now just 43 per cent, needs a win to help boost Democrats’ reelection chances.

Graph 2, Market Commentary, 12.15.2021

Democrats are pursuing reconciliation, a streamlined legislative process tied to the budget, that enables the bill to pass by a simple majority, instead of relying on GOP support. All Build Back Better provisions must conform to the restrictions related to the process. Lawmakers expect that the provisions related to immigration and prescription drug prices will probably not qualify for reconciliation and may need to be dropped. Democrats have struggled within their party to raise enough revenue to cover the bill’s $2 trillion price tag, but faced strident opposition from Arizona Senator Kyrsten Sinema, who argued that lawmakers need to close existing tax loopholes before implementing new taxes.

The legislation, argued to be transformative, faces several challenges – not the least of which is the current inflation environment. Household demand and constrained supply have conspired to push price growth to levels not seen since the 1980s. Costs of food and shelter, the largest expenses faced by lower-income families, are becoming increasingly expensive. Meat prices are up over 16 per cent over the last 12 months, rent is 5.7 per cent more expensive and household utilities are more than 13 per cent costlier than they were last year. Notwithstanding recent wage increases, wage gains have trailed inflation consistently since April. High inflation disproportionately hurts low-income families, weighing on household attitudes. The University of Michigan’s Consumer Confidence Index plunged in November to 67.4, its lowest level in a decade. The bill, although theoretically designed to lower household costs, will likely increase inflation, rather than diminish it as President Biden suggests.

Graph 3, Market Commentary, 12.15.2021
Graph 4, Market Commentary, 12.15.2021

Build Back Better carries fiscal baggage, too. The legislation’s provisions, as written, would add about $231 billion to the deficit over the next decade, according to Congressional Budget Office calculations. That’s because many of its provisions expire over the next 10 years. However, if these provisions are extended, as is typical of government programs, it instead would add roughly $3 trillion to the deficit over a decade.

We agree that Build Back Better would fan the inflation flames. Economic principals are rigid. It is impossible for the federal government to raise living standards by simply writing checks. Without offsetting productivity gains, government support checks fuel increased demand and higher prices.  In the years leading up to the pandemic, wage growth and the cost of renting a primary residence moved in lockstep. That’s because higher wages spur rental demand, pushing rents higher in tandem. President Biden’s Build Back Better plan comes on the heels of the $1.8 trillion American Rescue Plan earlier this year and last year’s $1.7 trillion CARES Act, $880 million Response and Relief Act, $483 million Paycheck Protection Program extension and $192 million Employer Paid Leave bill.  It’s no wonder we’re experiencing the highest inflation in 40 years.

Graph 5, Market Commentary, 12.15.2021

It’s unlikely Build Back Better will see the light of day by year-end. If the bill ever comes to pass, we expect it would be substantially smaller than its current incarnation. Like the bond market, we’re anticipating a rapid deceleration of inflation, with CPI dropping toward 2.5 per cent by the end of next year on its way toward 2 per cent thereafter. The passage of Build Back Better in its current form would force us, and the market, to rethink our inflation outlook and risk position.

Graph 6, Market Commentary, 12.15.2021
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