Need for Speed Part 1: The Case for Additional Fiscal Stimulus

As America continues its fight against COVID-19, its economy has taken a serious battering. Even after two major rounds of fiscal stimulus totaling nearly $3 trillion, jobless claims have soared past 35 million in the last eight weeks as large swaths of the country shut down to slow the spread of the virus. Total nonfarm payroll employment fell by 20.5 million in April while unemployment reached 14.7%. The numbers undercount the losses due to methodology and labor force participation rate decline, yet they still represent the largest over-the-month loss in the history of the series.  As hard to believe as this may be, current fiscal stimulus is insufficient. We must act bigger and faster if we hope to come out of this crisis any time soon.

Other recently released economic data paints a similarly grim picture. In March, manufacturers’ monthly new durable-goods orders fell 16.2% YoY as the industry shed 1.4 million jobs, wiping away a decade of employment gains. Meanwhile, retail sales in April fell a record 16.4% following an 8.3% drop in March. Clothing stores performed especially poorly: sales experienced a two-month decline of 89%. GDP decreased at an annual rate of 4.8% in the first quarter of 2020 and Q2 estimates hover around a 40% decline. Federal Reserve Chairman Jerome Powell may have put it best when he described the crisis as causing “a level of pain that is hard to capture in words.”

Against this backdrop, the Federal Reserve has pulled out all the stops to support the economy. Beyond lowering the fed funds rate target to 0-0.25 percent, setting the discount rate to 0.25 percent, and initiating unlimited large-scale asset purchases, the Fed has committed to buying state and municipal bonds. Although the Fed has always been empowered to do the latter, it never did so out of concerns over the potential politicization of the process. 

In conjunction with Congress, the Fed has also tackled the lending front through a raft of programs targeting banks, large firms, main street, and small businesses. Through a combination of new and old programs revived from the Great Financial Crisis, the Fed has done virtually everything in its power to stymie the economic loss from COVID-19. Although negative interest rates have been mentioned by market participants, the October 2019 FOMC minutes show little appetite for such action. Although Powell is probably not wrong to believe the Fed is “not going to run out of ammunition” to support the economy, this does not mean the central bank is best equipped to address the economic fallout of the virus. That honor belongs to Congress.

One of the primary reasons why the Fed has struggled to mitigate the economic effects of the pandemic is the source of the shock. Central banks are far better at addressing demand-side shocks than supply shocks. COVID-19 touches both supply and demand but not in ways the Fed can do much about directly. Second, the Fed has the power to lend but not the power to hand out cash. Powell himself mentioned this limitation in addressing the need for fiscal policy to act bigger and faster. 

Additional fiscal stimulus is critical to addressing the economic devastation wrought upon the nation and ensuring the recovery is as short as possible. There is broad consensus that fiscal stimulus is helpful in stimulating economic growth and promoting a quick recovery when there is significant slack in the economy. Studies have shown fiscal intervention, in cooperation with complementary monetary policy, was critical in supporting two past economic recoveries, the Great Recession and Great Depression. Moreover, evidence exists that premature withdrawal of fiscal support, as happened in the mid-1930’s USA and post-Great Recession Europe, hampered the recovery process.

One area where this stimulus will be desperately needed is local government. Unlike the federal government, almost all states and municipal governments are required to balance their budgets. The current crisis has dramatically increased spending while decreasing incoming revenues. All over the country, states and cities are experiencing budget shortfalls as a result of responding to the virus. The situation, combined with reduced demand for state and muni bonds, is an impending crisis. Without additional fiscal support, local governments will have to cut services, jobs, or likely both. The economic fallout is not unique to any region of the country and will be felt all around. Without federal support, the economic drag of the job losses and decreases in aggregate demand will greatly hamper our economic recovery.

There is an urgent need for additional and greater fiscal policy response to the current crisis. Although the costs will be great, the cost of not doing enough will be far greater. If we wait too long to “see the effects” of what we have already done, or declare victory too soon, we will subject ourselves to an unnecessarily prolonged recovery.  Beyond the immeasurable physical and emotional pain inflicted on so many of our fellow Americans, the preservation of our economy and future economic growth also depends on a forceful response by Congress. The details of such a policy are outside the scope of this article and I am far from an expert in how that is best implemented. The economic evidence is clear, however, that fiscal stimulus is both effective and necessary in times like these. 

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