Please answer all portions of the question the article is placed below.
1. This questions is based on the article, "Deutsche Bank Issues Stark US Inflation Warning, Seeing Economic Parallels to 1940s, 1970," published on the website of coindesk.com on June 7, 2021. The article summarizes the messages of a report by Deutsche Bank on the potential trends in the U.S. economy and the possible policy responses to them in the next couple of years.
(a)The article suggests that the output gap of the U.S. economy at the end of 2020 stood at about -3% (see the chart in the article) but may rise to 2% (or more) in 2021/2022 (see the grey line in the chart which corresponds to the Deutsche Bank projected baseline[1]). According to the article, what factors may contribute to this dramatic change and thus contribute to inflationary pressures by increasing aggregate demand? Note: Consider factors that impacted consumption (C) and investment (I) and make sure to explain the mechanism of their work.
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(b)From the material presented in the article, is the Fed following an optimal Taylor rule or deviating from such a rule? What are the risks of deviating from the rule? Please justify your conclusions; and make sure to explain what Taylor Rule is in your response.
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(c)According to the article, how do U.S. macroeconomic policies under the COVID-19 pandemic compare with the policies adopted in response to the 2008 financial crisis? Note that there was no inflation in the aftermath of the financial crisis. Does the article portray the policy response to the 2008 financial crisis as optimal or sub-optimal?
Answer:
Jun 7, 2021 at 12:12 p.m. CDT . Updated Jun 8, 2021 at 8:30 a.m. CDT y f in Deutsche Bank, Germany's largest lender, says the U.S. might be headed for one of its worst inflationary periods in history, arguing that elevated government spending and loose monetary policy could combine to create conditions similar to prior episodes in the 1940s and 1970s. Adding to the pressures are some $2 trillion of "excess savings" that consumers have amassed over the past year, when many businesses were closed and travel mostly shut down, according to the report published Monday. "Consumers will surely spend at least some of their savings as economies reopen, wrote Deutsche Bank Chief Economist David Folkerts-Landau along with Peter Hooper, global head of economic research, and Jim Reid, head of thematic research.. "This raises the very real specter of consumer-driven inflation."Inflation is closely watched by cryptocurrency investors who view bitcoin (BTC, -4.84%) as a hedge against dollar debasement. Subscribe to Crypto Long & Short, our weekly newsletter on investing. Your email address SUBSCRIBE By signing up, you will receive emails about CoinDesk products and you agree to our terms & conditions and privacy policy. But bitcoin has also traded at times in sync with risky traditional assets like stocks, and the Deutsche Bank authors warned that when inflation does eventually appear, the Fed might have to react forcefully, which could "create a significant recession and set off a chain of financial distress around the world." The warning comes in marked contrast to Federal Reserve Chair Jerome Powell's repeated assurances that elevated inflation readings are probably "transitory," and will settle back over time as the economy recovers from last year's pandemic-induced recession. ADVERT SEMEN"A lack of preparation for the return of inflation is concerning. Even if some inflation today is transitory, it may feed into expectations as in the 1970s," according to the report. "Even if only embedded for a few months, these expectations may be difficult to contain with stimulus so great." One signal to watch is the output gap, which measures the imbalance between demand and supply, expressed as a percentage of an economy's gross domestic product. Deutsche Bank expects the U.S. output gap to rise above 2%, the highest in over two decades as demand exceeds supply, resulting in higher prices. After the financial crisis of 2008, the "quantity of U.S. stimulus was insufficient to close the output gap, and the recovery was needlessly slow." But an elevated output gap during the 1960s preceded the high inflation of the 1970s, which was exacerbated by a series of oil-price shocks.Figure 9: US output gap (plus projections) as a proportion of potential GDP (%) 6 6 3 CBO baseline 6 DB baseline High growth -12 1965 1975 1985 1960 1980 1990 1995 2000 2005 2010 1970 2015 2020 Source : BEA CUO, Devische Back Chart shows estimates of the U.S. output gap, which attempts to measure the imbalance of supply and demand as a share of GDP. It is typically used to assess potential growth and inflation. Source: Deutsche Bank Deutsche Bank estimates that legislated stimulus packages have totaled in excess of $5 trillion, or more than 25% of gross domestic product. The U.S. federal deficit is likely to come in at 14% to 15% of GDP in both 2020 and 2021, versus about 10% in 2009.Around World War II, according to the economists, U.S. deficits remained between 15% to 30% for four years. "While there are many significant differences between the pandemic and WWII we would note that annual inflation was 8.4% in 1946, 14.6% in 1947 and 7.7% in 1948 after the economy normalized and pent-up demand was released," according to the report. The current political climate means that jobs growth may be a higher priority in the coming years than keeping inflation at bay. Unlike in the early 1980s, when then-President Ronald Reagan supported Fed Chair Paul Volcker "putting the economy through a wringer to quell inflation, the problem is today viewed as much less important than unemployment and the broader goals of achieving greater equality in income and wealth," according to the report. "The Fed's move away from preemptive action in its new policy framework is the most important factor raising the risk that it will fall well behind the curve and be too late to deal effectively with an inflation problem without a major disruption to activity," the authors wrote
