The U.S. economy could use some “overheating”: Biden’s relief and recovery plan meets the scale of the economic crisis

Key takeaways:

  • President-elect Biden’s recently announced relief and recovery plan is highly unlikely to cause economic “overheating”—and it would be a sign of its success if it did.
  • Economic “overheating” generally means large and prolonged increase in inflation and/or interest rates, but the U.S. economy has run far “too cold” for decades, largely due to the enormous rise in income inequality redistributing income to richer households that save most of their income. Unless inequality is substantially reversed, economic overheating is highly unlikely.
  • Even when the unemployment rate was 3.7% in 2019, there was no sign at all of economic overheating. Any relief and recovery plan would have to push the unemployment far beneath this for an extended period of time before any real overheating could happen.
  • Common metrics that deficit hawks often point to as evidence of economic overheating are not convincing.
    • The debt service burden is actually historically low in recent years due to the too-cold economy of recent decades
    • The overall ratio of federal debt to GDP would actually likely be lower years from now if Congress passed the Biden plan, because such plans would increase GDP.

Recent proposals for large-scale fiscal relief and recovery from the economic effects of COVID-19 have drawn criticism that they could lead to “overheating” of the U.S. economy. These criticisms should be ignored. Proposals under discussion—including Biden’s economic plan introduced tonight—are highly unlikely to lead to any durable uptick in inflation or interest rates (the normal indicators of “overheating”) and even if they did, these higher interest rates and inflation would be a welcome sign of economic healing, not something to worry about.

Warnings about economic “overheating” normally mean that growth in spending by households, businesses, and governments (known as aggregate demand) will outpace growth in the economy’s productive capacity—the stock of potential workers and capital that can be used to produce goods and services to satisfy aggregate demand. When demand growth outpaces growth in the economy’s productive capacity, the result can be upward pressure on inflation (too much demand chasing too few goods and services which drives up prices). In normal times, the Federal Reserve is the nation’s inflation guard dog, and if upward pressure on inflation threatened to move it durably above what the Federal Reserve has announced as its inflation target (2%), the Fed will raise interest rates to slow growth in aggregate demand. The overheating concern is often directed at any deficit-financed fiscal plan ), as the Biden relief and recovery plan appropriately is.

But profound changes in the U.S. and global economies over the past generation have made it much harder to “overheat” the economy, and, in fact, have made a too-cold economy the bigger problem. Most notably, the huge rise in inequality has redistributed income to wealthier households much more likely to save it rather than spend it. All else equal, this has slowed aggregate demand growth and made it less necessary for the Fed to raise interest rates to fight off inflation driven by overheating (some times this chronic demand shortfall is called “secular stagnation”, sometimes it is referenced as the “falling neutral rate of interest”, but, the upshot is clearly that demand-growth is running too-cold). Some quick numbers to make the point: Between 1979 and 2000, the main interest rate controlled by the Fed averaged over 7%. Since 2000 it has averaged 1.7%, and since 2007 less than 1%. Overheating has become a far less pressing problem for the US economy, even if too many economic observers and policymakers haven’t fully realized it.

The 2019 labor market—the last year before the COVID-19 shock—also illustrates how hard it is to overheat the modern U.S. economy. The unemployment rate averaged 3.7% that year, the lowest level since 1969. Normally, this unemployment rate would be low enough to make economists worry that empowered workers would demand wage increases in excess of the economy’s ability to deliver them, leading to wage-driven inflation. However, wage growth actually slowed in 2019, but for mostly good reasons: The high-pressure labor market was drawing in less experienced and credentialed workers who normally have more trouble finding steady work, and adding these lower-paid workers to wage data mechanically slowed measures of average wage growth. And yet, even as these workers were added to the workforce and wage growth slowed, productivity—or how much income is produced in the economy overall by an average hour of work—grew faster, expanding the economy’s ability to produce goods and services and dampening inflationary pressures. This rise in productivity as labor markets tighten was predictable and provides a built-in check against overheating. In turn, core inflation in 2019 didn’t accelerate measurably at all.

The Fed itself has been far more worried about too-low inflation than overheating in the last decade. They have stressed that their inflation target should not be interpreted as a hard ceiling above which inflation is never allowed to go. Instead, they have clarified that the 2% inflation target is a “flexible average inflation target” over time. Practically, this implies that long periods of inflation below 2% should be made up by extended periods above 2% before interest rates are raised. Given that inflation spent most of the past 14 years well below this target, it would take a relatively long period of inflation significantly higher than 2% before the Fed would begin steadily raising interest rates.

The upshot of this examination of the 2019 economy is that a relief and recovery plan could —and should—push the unemployment rate substantially lower than what prevailed pre-COVID before it was clear that the Federal Reserve would be hesitant to even begin raising interest rates. With that said, it is far from clear that even the admirably ambitious Biden plan would push the unemployment far beneath its 2019 level anytime soon. Because the chronic demand shortfalls of the last decade or more have led to historically low interest rates, they have significantly eroded one standard measure of the burden of federal debt: interest payments on this debt expressed as a share of overall gross domestic product (GDP). Despite a large rise in the overall debt as a share of GDP (more on this below) in recent years, falling interest rates have kept the debt service burden historically low. In fact, adjusted for inflation, the debt service “burden” is negative, meaning that investors are paying the Federal government for taking on its debt. Too often, commenters mistakenly treat this low debt service burden as a lucky fluke that could reverse any day. But it’s not a fluke, it’s the outcome of the bigger problem of the chronic shortfall in demand—a problem that was been with us (and growing) for decades and which will only be clearly solved when policymakers address its root causes, such as growing income inequality.

Those looking to whip up fears about federal debt often point to another (less informative) measure: the overall ratio of federal debt to GDP. Despite common claims, this measure tells us nothing about how “sustainable” the federal debt is, since it is entirely a backwards looking measure (i.e., the current stock of debt only tells us about deficits run in the past that resulted in this debt but tell us nothing about the likely trajectory of debt or GDP going forward). But setting aside this measure’s irrelevance for debt sustainability, it is far from clear that the Biden relief and recovery plan will even increase this measure in the medium term. What happens to the ratio depends on both the numerator (debt) and the denominator (GDP). If additions to debt are used to finance spending and investment and relief measures that raise GDP, then this will serve to reduce the debt ratio. The Biden plans will indeed raise GDP— the evidence showing that deficit-financed spending undertaken during times of economic distress boosts growth is huge and incontrovertible. This extra GDP growth will in turn boost tax revenues, which will put some downward pressure on debt growth relative to the status quo—that is, a nontrivial part of these spending and relief measures will be self-financing. In fact, when assessing the various influences together as a whole, it is highly likely that the debt ratio five years from now would be lower because the Biden relief and recovery plan will lead to a much faster recovery than if we hadn’t acted.

The possibility of a lower debt ratio emerging due to the relief and recovery plan is not, obviously, the reason to undertake this. The plan should be undertaken because the U.S. economy remains deeply damaged, people are suffering, and it’s time policymakers made a labor market with plenty of jobs and sustained upward pressure on wages a top priority. But, the likely prospect of this package actually reducing the debt ratio just shows how misplaced typical anti-deficit arguments are in this time.

We’ve suffered from a too-cold economy for far too long—it’s time to turn up the heat, a lot. To its credit, the Biden relief and recovery plan aims to do this.

Unemployment claims increase as COVID-19 surges

Another 1.2 million people applied for Unemployment Insurance (UI) benefits last week, including 965,000 people who applied for regular state UI and 284,000 who applied for Pandemic Unemployment Assistance (PUA). The 1.2 million who applied for UI last week was an increase of 304,000 from the prior week. The increase was due in part to data volatility during a messy time for UI data—the holidays, the President delaying signing the relief bill until the day after the pandemic programs expired—but the 181,000 rise in seasonally adjusted regular state claims suggests layoffs are increasing as the COVID-19 pandemic surges.

Last week was the 43rd straight week total initial claims were greater than the worst week of the Great Recession. (If that comparison is restricted to regular state claims—because we didn’t have PUA in the Great Recession—initial claims last week were still greater than the worst week of the Great Recession.)

Most states provide just 26 weeks of regular benefits, so many workers are exhausting their regular state UI benefits. In the most recent data, however, continuing claims for regular state UI rose by 199,000, meaning new continuing claims were outpacing exhaustions. After an individual exhausts regular state benefits, they can move onto Pandemic Emergency Unemployment Compensation (PEUC), which is an additional 24 weeks of regular state UI (the December COVID-19 relief bill increased the number of weeks of PEUC eligibility by 11, from 13 to 24).

However, in the most recent data available for PEUC, the week ending December 26, PEUC claims dropped by 325,000. That was likely due largely to exhaustions. Well over 2 million people had exhausted the original 13 weeks of PEUC before Congress passed the extensions (see column C43 in form ETA 5159 for PEUC here). These workers are eligible for the additional 11 weeks, but they will need to recertify. We can expect PEUC numbers to swell dramatically as this occurs. It should be noted, however, that in some states, if workers exhaust PEUC, they can get on yet another program, Extended Benefits (EB). In the latest data, the number of workers on EB increased by 375,000, offsetting the drop in PEUC. Workers on EB will stay on EB until they exhaust their EB benefits before switching back to PEUC for the additional 11 weeks of PEUC eligibility.

Continuing claims for PUA dropped dramatically, by 940,000, in the latest data. The latest data for this series is also for the week ending December 26. This was before the relief bill was signed, so that drop was also likely due to temporary exhaustions. The December COVID-19 relief bill extended the total weeks of eligibility for PUA by 11, from 39 to 50 weeks. As workers who exhausted PUA before the extensions were signed get back on PUA, we can expect the PUA numbers to swell.

The 11-week extensions of PEUC and PUA just kick the can down the road—they are not long enough. Congress must provide longer extensions, or millions will exhaust benefits in mid-March, when the virus is likely still surging and job opportunities still scarce.

Figure A shows continuing claims in all programs over time (the latest data are for December 26). Continuing claims are still more than 16 million above where they were a year ago, even with the exhaustions occurring during the time period covered by this chart. The recent sharp declines in PUA in particular are very likely due to temporary exhaustions and will be reversed as people get back on the program.

Figure AFigure A

There are now 26.8 million workers who are either unemployed, otherwise out of work because of the virus, or have seen a drop in hours and pay because of the pandemic. Further, we started losing jobs again in December; layoffs are rising and the virus is surging. More relief is desperately needed. A key reason more relief is so important is that this crisis is greatly exacerbating racial inequality. Due to the impact of historic and current systemic racism, Black and Latinx workers have seen more job loss in this pandemic, and have less wealth to fall back on. To get the economy back on track in a reasonable timeframe, we need policymakers to pass an additional $2.1 trillion in fiscal support (the $2.1 trillion is calculated by subtracting the $900 billion December COVID-19 relief bill from the total $3 trillion in fiscal support that is actually needed). In particular, it is crucial that Congress provide substantial aid to state and local governments. Without this aid, austerity by state and local governments will result in cuts to essential public services and the loss of millions of jobs in both the public and private sector.

Senate Republicans forced the December bill to be far too small. Fortunately, with their new majority in the Senate, Democrats will now be able to get more relief measures through reconciliation. Top priorities are aid to state and local governments, additional weeks of UI, and increased UI benefits.

Twenty states raised their minimum wages on New Year’s Day: Federal action is still needed

On January 1, minimum wages went up in 20 states. The increases range from an $0.08 inflation adjustment in Minnesota to a $1.50 per hour raise in New Mexico, the equivalent of an annual increase ranging from $166 to $3,120 for a full-time, full-year minimum wage worker. The updates can be viewed in EPI’s interactive Minimum Wage Tracker and in Figure A and Table 1 below.

In prior years, we have estimated the number of workers who would directly benefit from these increases, as well as the total dollar amount and average wage increase for affected workers in each state. Unfortunately, current circumstances make it difficult to accurately produce estimates of this year’s increases. The COVID-19 pandemic has devastated labor markets throughout the country, with a large share of the job losses occurring in low-wage sectors, such as leisure and hospitality, where minimum wage hikes typically affect large shares of workers. Because conditions in these industries are so different from what they were in the period reflected in our model’s underlying data, we cannot use it to make estimations about effects happening right at this moment.

Even so, we know that minimum wage increases are as crucial as ever in the current context—to protect low-wage workers from exploitation and continue toward the goal of a living wage for all workers. From a macroeconomic perspective, it’s smart policy: Low-wage households—who disproportionately benefit from increases to the minimum wage—are highly likely to quickly spend the extra dollars they receive, boosting consumer demand as we move into recovery.

Figure AFigure A State minimum wage increases

The January 1 increases in nine states—California, Illinois, Maryland, Massachusetts, Michigan, New Jersey, New Mexico, New York, and Vermont—are the result of legislation passed by state lawmakers to raise their state’s wage floors.

In two states—Arkansas and Missouri—the January 1 raises result from ballot measures passed by the state’s voters.

In nine states, the changes are the result of automatic annual inflation adjustments. Alaska, Arizona, Colorado, Maine, Minnesota, Montana, Ohio, South Dakota, and Washington all have provisions in their state minimum wage laws that require the wage be adjusted annually to reflect changes in prices over the preceding year. Doing so ensures that the minimum wage never declines in purchasing power, and workers paid the minimum wage can afford the same amount of goods and services year after year. Eight other states and the District of Columbia have enacted similar automatic adjustment provisions in their minimum wage laws that will begin after their minimum wages reach a higher statutory level in the coming years.

Table 1Table 1

In addition to the increases that took effect in 20 states on January 1, five other states (Connecticut, Florida, Nevada, Oregon, Virginia) and the District of Columbia have minimum wage increases scheduled to occur later in 2021.

Local minimum wage increases

Currently, 44 localities—cities and counties—have minimum wages that are higher than their state minimum wage. These range from $12.10 in Santa Fe, New Mexico, to $16.84 in Emeryville, California.

Of these, 22 raised their minimum wages on January 1.[i] Table 2 shows these New Year’s Day increases.

[i] This includes Nassau, Suffolk, and Westchester Counties in New York, grouped together as one locality in Table 2. These counties have minimum wages higher than upstate as a result of state law, not individual county-level ordinances.

Table 2Table 2

Thirteen more of these 44 cities and counties are slated to raise their minimum wages later in 2021: Berkeley, Emeryville, Fremont, Milpitas, San Francisco, and Santa Rosa, California; Chicago and Cook County, Illinois; Montgomery County, Maryland; Minneapolis, Minnesota; Portland Urban Growth Boundary, Oregon; and Santa Fe City and Santa Fe County, New Mexico.

Current minimum wages and information about upcoming wage increases for all states and localities can be viewed in EPI’s Minimum Wage Tracker.

The federal minimum wage and the Raise the Wage Act

The federal minimum wage has been stuck at $7.25 for more than a decade. Since it was last raised in July 2009, the minimum wage’s purchasing power has declined by more than 17% , leaving millions of workers and their families with paychecks that may no longer afford the things they need.

In response to federal inaction, an increasing number of states have raised their own minimum wage above the federal level. So far, 29 states have a minimum wage that is higher than the federal minimum wage. These range from $8.56 in Florida to $14 in California. The District of Columbia has a $15 minimum wage. In the 21 remaining states, the federal minimum wage applies (although one of these states, Virginia, is set to raise its minimum wage to $9.50 in May 2021, with subsequent increases taking the state minimum to $15 in 2026). These measures have helped millions of low-wage workers see larger paychecks, as research shows that wage growth for low-wage workers has been markedly faster in states that have raised their minimums.

Nine states—California, Connecticut, Florida, Illinois, Maryland, Massachusetts, New Jersey, New York, and Virginia—have passed legislation or ballot measures that will eventually bring their state minimum wages to $15 an hour.

With a new Congress recently sworn in, a change in Senate control, and a new president soon to be inaugurated, prospects for a federal minimum wage increase look more promising than they have in a long time. In July 2019, the U.S. House of Representatives passed the “Raise the Wage Act of 2019,” a bill that would raise the federal minimum wage to $15 by 2025. However, the Act stalled in the Senate. But with Democrats winning control of the Senate and the presidency, the 117th Congress may finally achieve a policy goal that economic and racial justice advocates have been demanding for over 50 years. As economic research continues to show that higher minimum wages work precisely as they’re intended—lifting pay for low-wage workers with little, if any, impact on their job prospects—there is no excuse for lawmakers not to finally agree to that demand.

Enjoyed this post?

Sign up for EPI's newsletter so you never miss our research and insights on ways to make the economy work better for everyone.

The Trump administration finalizes rule attacking federal workers’ right to union representation in workplace discrimination cases

In his final weeks in office, the Trump administration continues to attack federal workers’ right to union representation. Last week, the Equal Employment Opportunity Commission (EEOC) voted to finalize a rule that prohibits union representatives from using official time—which is paid work time representatives use for union activities—to represent their coworkers in equal employment opportunity (EEO) matters, overturning almost 50 years of precedent. By prohibiting union representatives from using official time during EEO matters, the final rule effectively limits the right of federal workers to choose their representative in the EEO complaint process.

The rule also creates enormous cost burdens for federal workers who want to file a workplace discrimination complaint. By prohibiting the use of official time in discrimination complaints, federal workers are faced with the choice of hiring a private attorney or asking an inexperienced coworker to be their representative on their own free time. The cost of an attorney will be too costly for many vulnerable federal workers, and between the choices of hiring an attorney, asking an inexperienced coworker to be a representative, or not filing at all, many will forgo exercising their rights.

This is only one of many ways the Trump administration has attacked federal workers’ unions. During his first year, President Trump issued three executive orders eroding the collective bargaining rights of federal workers. These orders shortened the timeframe expected to complete bargaining and directed agencies not to bargain over certain topics, limited the use of official time for collective bargaining activities, and weakened due process protections for federal workers subject to discipline. In October 2019, Trump signed an executive order revoking an executive order issued by former President Obama that gave employees of federal contractors the right of first refusal for employment on a new contract when a federal service contract changes hand.

These actions directly impact millions of federal workers covered by a union contract. As shown in Table 1, 30.5% of federal workers are covered by a union contract, compared to 11.6% of workers overall. An attack on federal unions has a disproportionate impact on workers of color. Hispanic/Latinx (34.4%) and Asian American/Pacific Islander (AAPI, 33.4%) federal workers are more likely to be unionized than white federal workers (30.2%).

Table 1Table 1

The EEOC’s final rulemaking on official time also has serious implications for Black workers, who account for 1 in 5 (20.5%) federal employees covered by a union contract, far higher than Black workers’ share of the overall workforce (12.7%), as seen in Table 2. Historically, the public sector has employed higher shares of Black workers than the private sector, thanks in part to the anti-discrimination protections that the federal government adopted in the 1960s and 1970s.

Table 2Table 2

The EEOC’s final rulemaking on the use of official time is just one of many anti-worker regulations the Trump administration has issued over the last four years. Fortunately, Senate Democrats—with their newfound majority—can overturn this latest attack on federal unions through the Congressional Review Act. Further, President-elect Biden can issue executive actions to overturn Trump’s anti-worker executive orders on day one. But simply reversing the Trump anti-worker agenda will not be enough. The Biden administration must also advance measures that provide the federal workforce, including federal contractors, with strong labor and employment protections.