Did the American Rescue Plan cause inflation? A synthetic control approach

Abstract

This paper investigates the fiscal impact of the American Rescue Plan (ARP) on the post-pandemic surge in U.S. inflation. In the existing literature, the dominant strategy for identifying inflation determinants is through structural or reduced-form equation modeling; however, a definitive consensus on the causes of the U.S. inflationary episode remains elusive due to a lack of data-driven counterfactual analysis. To address this gap, we uniquely apply a synthetic control approach to estimate the causal effect of the ARP on U.S. inflation. The findings reveal that the ARP excessively stimulates aggregate demand via large-scale unfunded transfers, causing U.S. inflation to deviate upward from its counterfactual path. Moreover, this policy intervention significantly elevates inflation expectations and diminishes consumer confidence, thereby activating the fiscal limit mechanism: unfunded fiscal shocks, combined with waning fiscal credibility, lead private agents to anticipate that national debt will be inflated away, resulting in large and persistent inflation.