Fact Check: Is Federal Spending Driving Inflation?

Inflation has risen sharply in the U.S. as the economy rapidly grows—albeit more slowly than anticipated by analysts—unemployment falls, and the threat from the pandemic eases amid widespread vaccination of the population.

The Claim

Republicans are pinning the current period of high inflation on federal spending under President Joe Biden and the Democratic majority in Congress.

"When it comes to spending, spending trillions is what is driving inflation," Senator Ted Cruz (R-TX) recently told Newsmax, per a clip of the interview he tweeted on July 29.

"We're seeing an inflation bomb growing across our economy. Americans across the economy are seeing the price of food go up, are seeing the price of gasoline go up, are seeing lumber go up, are seeing houses go up.

"And the Democrats are just pouring gasoline onto the fire with trillions more in spending."

Cruz emphasized the point in his tweet: "Democrats want to spend trillions upon trillions of dollars. This reckless spending is what is driving inflation. Republicans need to hold the line against this spending that is hurting working families across this country."

The Facts

A big portion of the trillions of dollars of stimulus spending was agreed on a bipartisan basis before Biden took office, when Trump was still in power and the Republicans had control of the Senate.

Government data shows $4.6 trillion is the total cost of the federal COVID response to date. Biden's relief bill, signed in March 2021, came at a total cost of $1.9 trillion. Much of the spending predates Biden and Democratic control of Congress.

There is a bipartisan $1 trillion infrastructure bill working its way through Congress. But this spending isn't even approved yet, much less spent. So, when considering inflation, we're only talking about the federal spending that has already made its way into the economy.

Now, let's look at the inflation picture. The Consumer Price Index for All Urban Consumers (CPI-U) measure of inflation gives a broad, headline reading of how prices are changing over a period of time for the vast majority of American consumers.

This index figure is calculated from the price changes of a basket of goods and services commonly purchased by consumers, including but not limited to "food, clothing, shelter, fuels, transportation, doctors' and dentists' services, drugs."

Each of these goods and services are weighted to "represent their importance in the spending of the appropriate population group" of the local area in which the prices are recorded for the index.

The CPI-U rose by 5.4 percent year-on-year in June, according to the Bureau of Labor Statistics, the largest annual increase since August 2008. The monthly rise was 0.9 percent, the largest since June 2008.

In its report, the BLS highlighted in particular the sharp rise in the price of cars and trucks (10.5 percent) and said this alone accounted "for more than one-third of the seasonally adjusted all items increase."

Additionally, the BLS highlighted a 0.8 percent increase in June's food prices—up from 0.4 percent in May—and a 1.5 percent rise in energy prices, notably a 2.5 percent monthly jump in its gasoline index.

Inflation has followed a rising trend since October 2020, a month before the election and three months before Biden took office and the Democratic majority entered Congress.

According to the July 28 statement from the Federal Reserve's Federal Open Market Committee (FOMC), which sets monetary policy with the goal of reaching a 2 percent inflation rate and maximum employment: "Inflation has risen, largely reflecting transitory factors."

So what is behind the recent price inflation? There are a few reasons inflation is rising fast. Federal spending is a factor, but it's not the biggest or most important.

The first is there was deflation in March, April and May 2020. This fall in prices, linked to the sharp economic contraction at the same time due the pandemic, accentuates the recent inflationary spike in the year-on-year data. It's known as the base effect.

Greg McBride, chief financial analyst at Bankrate, noted to Newsweek that June's inflation would be three percent if it were compared to the same period in 2019, when conditions were normal before the pandemic. Still high, but not nearly as bad as 5.4 percent looks.

Moreover, McBride pointed to the outpouring of pent-up demand now the pandemic is subsiding, restrictions are easing, and 70 percent of the adult population is vaccinated.

This spike in demand as the economy returns to normal is putting pressure on reduced supply for some goods and services, which are slower to get back to where they were.

For example, the production of cars and trucks is impacted by the semiconductor chip shortage. Airlines are slower to get their airplanes back into service—hangared because the pandemic stopped people flying—than the rise in demand from air passengers, driving up airfares.

Andrew Hunter, a senior U.S. economist at Capital Economics, concurred.

"A significant chunk of the rise in inflation so far has been driven by a small handful of categories most directly affected by the pandemic and recent easing of restrictions—e.g. airfares, hotel room rates, car rental prices," Hunter told Newsweek.

"To the extent they reflect temporary imbalances of supply and demand, the upward pressure on prices in all of those categories should eventually fade. But there is still plenty of uncertainty over how and when that will happen."

Kathy Bostjancic, head U.S. financial market economist at Oxford Economics, told Newsweek that it's "easier to turn the economy off than back on" and the stimulus to support households and businesses was "quite successful."

"There's just a lot of supply chain disruptions," Bostjancic said. "The main issue is you've got a misalignment between supply and demand.

"Economics 101 will tell you whenever you have that misalignment you're going to have price frictions and that's why we've seen this flare up in inflation. The fact that supply is lagging so far behind, you could argue that's really the problem both in the labor and the product market."

Hunter said there are signs that used vehicle and car rental prices might drop "having significantly overshot pre-pandemic levels" but that "prices in those other categories have only just returned to pre-pandemic levels and could have much further to rise."

Bostjancic also said many companies have felt confident to pass higher costs onto consumers by raising their prices, particularly in the service sector. Pandemic-weary consumers, locked down and restricted for so long, just want to get back to normal—and are willing to pay for it.

"They're willing to do that because for many months we've been cooped up at home and really eager—in some instances desperate—to get back out there. So consumers are willing to tolerate the price increases. That's a unique period," Bostjancic said.

But she also thinks inflation has peaked, and that consumers will eventually tire of price rises and shift to other goods or spend less, acting as a drag on inflation.

Still, Bostjancic told Newsweek: "Inflation is going to remain sticky, above two percent, for the next couple of years as supply issues are worked out."

McBride, Hunter and Bostjancic acknowledged that the federal stimulus spending plays a role on the demand-side, though it is indirect and there are many other factors behind rising inflation, and the primary culprit is on the supply side.

"There isn't an automatic link between federal spending and inflation, but the stimulus checks and other spending policies have clearly provided a big boost to demand at a time when supply is still constrained," Hunter said. "In the short term at least that is usually going to lead to higher prices."

Labor shortages driving up wages may contribute to sustaining the inflationary rise. There is some suggestion, particularly in Republican-governed states, that the enhanced unemployment benefit—part of federal stimulus—is behind the labor shortages.

This may well be true, but it is still too early to draw a firm conclusion, and more research is needed. The Republican states recently opted out of enhanced unemployment benefit and the effects on their labor markets is yet to be seen.

An economic letter from the Federal Reserve Bank of San Francisco, which looked at the early research on this issue back in September 2020, concluded the enhanced unemployment benefit was not materially weighing on labor supply.

The enhancement "had little or no effect on the willingness of unemployed people to search for work or accept job offers," the letter said.

"This likely reflects the appeal of a sustained salary compared with even very generous unemployment benefits when labor market conditions are weak and virus containment measures prevent hiring."

But that is not the last word on the subject.

The Ruling

Fact Check - Half True

Half True.

FACT CHECK BY NEWSWEEK

Federal spending has contributed to higher demand in the economy, intended to help it recover from its pandemic-induced collapse.

Higher demand puts pressure on supply, which is not yet meeting demand because capacity was seriously curtailed during the pandemic and it takes longer to restore supply chains than it does for demand to recover.

Put simply, supply lags demand, which drives up prices. That much is true.

But Cruz's portrayal of federal spending's role in the current inflationary rise is misleading. Its effect on inflation is indirect, it is just one of several factors, and it is not the single most important. Supply side problems are the primary driver of this inflationary spike.

A spokesman for Cruz cited comments by Larry Summers, a prominent economist who has worked for Democratic administrations, warning over the past few months that the federal spending splurge risked fueling inflation.

"The aim of this fact check is not the truth. It's only to cover for Joe Biden and the Democrat party's disastrous fiscal policies," the spokesperson told Newsweek.

"In addition to Sen. Cruz, numerous economists including former Democrat Treasury Secretary Larry Summers have warned that Biden's spending spree is triggering inflation."

Republican senators show price inflation for consumers
Republicans accuse the Democrats of driving inflation higher with excessive federal spending. U.S. Sen. Ron Johnson (R-WI) speaks during a news conference about inflation on Capitol Hill on May 26, 2021 in Washington, DC. The group of Republican senators discussed rising consumer prices and the potential effects of inflation on families and businesses recovering from the pandemic. Drew Angerer/Getty Images