To pay for the full $4.1 trillion of excess spending, the unexpected boost in the price level needs to be larger: in the range of 19%, rather than 11% (though even this larger number assumes, perhaps too optimistically, that the government will not have more spending surges in the future). Starting in July 2022, the required price-level accommodation can be accomplished by 9.4% inflation over one year, 5.7% average inflation over two years, or 3.5% average inflation over five years.
All these intervals are followed by 2% inflation. The result for five years is not far from the bond market’s current breakeven inflation rate over a five year horizon. That is, the fiscal approach accords with expected inflation rates inferred from five year yields on conventional and indexed Treasury bonds.
So, a plausible argument is that the surge in federal spending triggered by the Covid-19 shock led to a permanent, unexpected rise in the price level by about 19%. This increase in the price level is a mechanism for financing the extra Covid-related spending. In a reasonable scenario, the CPI inflation rate comes down fairly quickly from its current value of 8.5% and averages around 3.5% over the next five years. While the inflation rate eventually returns to 2%, the upward surge in the price level is permanent. (The demand level of the upper quintile is not affected by the little bit of FED interest rate rise. From Barron's: "In the U.S. the top 20% of U.S. households account for nearly 40% of all consumer spending, or 28% of gross domestic product.” The "gap" is not going to affect that top 20% at all for a long time, if ever.)
The bottom line is that, although monetary policy was too aggressive for too long, the likely main culprit behind the recent high inflation was an extraordinarily expansionary fiscal policy.
Robert J. Barro, Professor of Economics at Harvard University, is a non-resident senior fellow at the American Enterprise Institute and a research associate at the National Bureau of Economic Research.