Fiscal Spending Could Cause a U.S. Growth Spike – Compounding Investors’ Concerns on Inflation

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 quarter-over-quarter annualized 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