Aug 2, 2022 - Economy

The problem with forecasting Manchin's Inflation Reduction Act

Senator Joe Manchin

Sen. Joe Manchin speaks to reporters about the Inflation Reduction Act he negotiated. Photo: Anna Moneymaker/Getty Images.

How much would the Inflation Reduction Act actually reduce inflation? In the calculations starting to emerge from economic modelers, the answer is "a little, maybe."

The big picture: Last week, Sen. Joe Manchin agreed to support legislation aimed at addressing global warming, reducing prescription drug costs, and cutting the deficit. Early estimates of how much it would reduce inflation, however, suggest a minimal impact.

  • Moody's Analytics estimates it will only reduce consumer prices by 0.33 percent over the coming decade. That's a total, not an annual number, meaning it would bring down the inflation rate only by three-hundredths of a percent per year.
  • The Penn-Wharton Budget Model finds the law would "very slightly" increase inflation in the next two years before reducing it thereafter, though those estimates are "statistically indistinguishable from zero."

Yes, but: This analysis shows the limitations of looking at laws aimed at fixing microeconomic problems, through a macro lens. These types of models are really not built to say anything terribly useful about how Manchin's legislation would affect the economy.

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

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

  • By Moody's estimates, it would spend an extra $43 billion a year over the next decade, and increase tax revenue by $74 billion. GDP, however, is on track to average $30 trillion a year over the next decade.
  • With a law that spends less than 0.2% of GDP per year, it's just hard to move the dial, in either direction, on macroeconomic aggregates like growth and inflation.
  • By contrast, the American Rescue Plan spent about 5% of GDP last fiscal year, so there is a much more plausible argument that it contributed significantly to growth and inflation.

Between the lines: The Inflation Reduction Act's exact impact will be impossible to know with certainty, even with hindsight, as any impact will be dwarfed by all the other things changing in the economy every month.

  • Its most significant effects will be on microeconomic goals like speeding a transition to cleaner forms of energy, keeping down drug costs, and reducing the deficit through more aggressive tax enforcement.
  • Conversely, to opponents of the legislation, the open question will be whether it worsens problems, such as disincentivizing pharmaceutical companies to invest in new drugs.

What they're saying: "While assessing the magnitude is always hard, it’s pretty clear directionally that this bill will help the Fed to fight inflation," Maya MacGuineas, president of the Committee for a Responsible Federal Budget, tells Axios.

  • "This bill is just a small piece of the puzzle, but it’s helpful to have fiscal policy and monetary policy finally rowing in the same direction," she said.
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