The Problem With Predicting Manchin’s Inflation Reduction Act

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To what extent would the Inflation Reduction Act actually reduce inflation? In the calculations that are beginning to appear from economic modellers, the answer is “a little, maybe”.

The big picture: Last week, Senator Joe Manchin agreed to support legislation aimed at tackling global warming, lowering the cost of prescription drugs and reducing the deficit. However, early estimates of the extent to which it would reduce inflation suggest a minimal effect.

  • Moody’s Analytics estimates it will cut consumer prices by only 0.33 percent over the next decade. That’s a totalnot an annual figure, meaning it would only cut inflation by three-hundredths of a percent per year.
  • The Penn-Wharton Budget Model finds that the law would increase inflation “very slightly” over the next two years before decreasing thereafter, although those estimates are “statistically indistinguishable from zero.”
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Yes but: This analysis shows the limitations of looking at laws aimed at solving microeconomic problems through a macro lens. Models like this really weren’t built to say anything very useful about how Manchin’s legislation would affect the economy.

  • They are built around high-level aggregates: for example, how would corporate tax increases affect capital investment, or how could a deficit reduction lower interest rates.

By the numbers: The bill is small potatoes in the context of the overall US economy.

  • Moody’s estimates it would spend an additional $43 billion over the next ten years and increase tax revenues by $74 billion. However, GDP is on track to average $30. reach trillion a year in the next ten years.
  • With a law that spends less than 0.2% of GDP per year, it’s just hard to move the knob either way on macroeconomic aggregates like growth and inflation.
  • By contrast, the US bailout last fiscal year spent about 5% of GDP, so there’s a much more plausible argument that it contributed significantly to growth and inflation.
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Between the lines: The exact impact of the Inflation Reduction Act will be impossible to determine with certainty, even in retrospect, as any impact will be overshadowed by everything else that changes in the economy every month.

  • The main effects will be on microeconomic goals such as accelerating a transition to cleaner forms of energy, keeping drug costs low and deficit reduction through more aggressive tax enforcement.
  • Conversely, for opponents of the legislation, the open question will be whether it exacerbates problems, such as discouraging drug companies from investing in new drugs.
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What they say: “While it is always difficult to estimate the magnitude, the guiding principle is quite clear that this bill will help the Fed fight inflation,” Maya MacGuineas, chair of the Committee on a Responsible Federal Budget, told UKTN.

  • “This bill is only one small piece of the puzzle, but it is helpful that fiscal and monetary policy are finally moving in the same direction,” she said.

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