Need for Speed Part 2: The Case for Additional Fiscal Stimulus

There are several concerns associated with the additional fiscal spending I advocated in my last article. One is the additional debt. Many people, including my colleague, Jack Geiger, have expressed concern about the size of the federal stimulus already enacted. I share his concerns on potential defaults by companies loaded up on debt from pre-COVID-19. However, I am less inclined to agree with his concerns regarding the federal debt, including the devaluation of the dollar and potential future tax increases, at this stage. 

Increases in the national debt should be viewed through the lens of our ability to service that debt. A common measure of that ability is debt relative to total output, or GDP. Multiple Fed presidents have expressed concern about the lasting damage this crisis will have on workers, firms, and the larger economy without further stimulus. Powell himself notes the potential for hysteresis due to prolonged unemployment, crushing debt loads for families trying to weather the crisis, and avoidable business insolvencies. Powell’s inclusion of the word avoidable is no coincidence. 

There is a strong belief that fiscal and monetary policy, working in tandem, is necessary to preserve as much of the pre-crisis as possible. “Reopening the economy,” “returning to normal,” or “getting on with our lives” will be made that much harder if more people find they do not have a job to return to afterwards. A working paper from University of Chicago on the job reallocation effects of the virus estimates “42 percent of recent layoffs will result in permanent job loss.” That is a terrifying prognosis but it need not be our reality. Though permanent job losses will happen, vigorous and timely fiscal policy can soften the blow for Americans while working to preserve our economy. 

One of the necessary features for government transfers to be effective is finding recipients with a high marginal propensity to consume (MPC). This magnifies the effects of cash transfers and stimulates the economy further than those with an inclination to save instead. In the current situation, this is far less difficult than usual. Observations by the Federal Reserve found a large portion of the jobs lost during the pandemic paid less than $40,000 a year. Many of these were likely in the retail, hospitality, and leisure industries. Combined with difficulties in saving and fewer benefits on the job, these people are likely to be hardest hit by the crisis and in need of help. They also tend to have the highest MPC. 

The intersection of these realities suggest fiscal policy and government transfers can have an outsized effect on economic stimulus compared to previous recessions which involved structural problems. Although extremely targeted fiscal policy could increase cost-effectiveness, broad measures in the current situation are more likely to satisfy the time-constraints relevant to the crisis. Our ability to preserve our economy, and thus our ability to service the national debt, require an urgency not inherent to narrowly scoped fiscal measures. In any case, I believe the income thresholds included in the CARES Act, though not particularly nuanced, have helped to target those with a comparatively higher MPC.

Another argument against additional fiscal spending that would increase our deficit is the potential for the government to draw down the pool of national savings. Often referred to as crowding out, the theory posits government lending will outcompete borrowers in the private sector, leading to reduced private capital investment and reduced long-term growth. This argument is predicated on the economy operating near potential output. Obviously, that is not the case. As the economy recovers, such concerns will become more valid but in the current situation, demand remains low and uncertainty has already prevented capital investment regardless of credit conditions.

Finally, inflation is an oft-mentioned concern when the government utilizes deficit spending.  There are a couple of reasons why this problem is unlikely to realize. The most important is the Federal Reserve. Developed economies with credible, independent, and transparent central banks, descriptors I would argue the Federal Reserve satisfies, have worked over the past few decades to manage inflation. By and large, this has been a success. Inflation expectations for the United States are well-anchored and the Fed has shown, through both its words and actions, an ability and willingness to act when things go awry. 

Second is the persistent, global demand for American Treasuries, which the government uses to fund its spending. Continued demand prevents the need to monetize our debt and spur inflation. Whether the driver is unstable domestic currencies, dollar-denominated debt, yield-seeking, or the need for safe assets, investors have flocked to American Treasuries. Several conditions make this unlikely to change for the foreseeable future. One is the prominence of the American economy, which is likely to remain one of the largest in the world even as China completes its ascension. As long as America continues to pay for goods globally with the dollar, and I am clueless as to what else they would consent to using, people around the world will want the dollar. 

Another is the use of dollar-denominated debt in many countries. The large amounts of dollar-denominated debt globally will require governments to procure dollars to service the debt. Finally, the continued dominance of the dollar is assisted by monetary actions such as the liquidity swaps initiated by the Federal Reserve. Borne out of other countries’ and firms’ need for dollars to service debt, the liquidity swaps provide direct access to the dollar for other central banks who in turn provide them to domestic firms. By maintaining liquidity and access to the dollar, The Federal Reserve also helped to extend and tighten the reach of the dollar in global financial markets. With persistent demand for American treasuries, it is highly unlikely our government would be unable to find investors and turn to alternative paths that could realize inflation concerns.

Beyond debt concerns, Barrero et al. argue “[u]nemployment benefit levels that exceed worker earnings, policies that subsidize employee retention, occupational licensing restrictions, and regulatory barriers to business formation will impede reallocation responses to the COVID-19 shock.” The study ignores the contribution of benefits to holistic wages, the dangers of hysteresis for employees of otherwise sustainable firms, and the effects of fiscal stimulus on economic recovery. Structural unemployment is unlikely to be exclusive to either world, but the one with additional fiscal support is likely to be better positioned to adapt. People who lack the funds for food and shelter probably do not care about a potential skills mismatch right now. 

I will say it again. 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.  Concerns about our national debt are valid in the long run but now  is not the time. 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 economic evidence is clear, however, that fiscal stimulus is both effective and necessary in times like these. 

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