As coronavirus seriously threatens the economy, fiscal stimulus is suddenly back in the public discussion. It should never have gone away. Demand for goods and services weakens and likely falls in a recession, and fiscal policy can raise demand to needed levels. But even now, this is not fully understood.
The immediate response to coronavirus (COVID-19) needs to be around public health, and the contours of economic crisis are closely linked to how effectively the spread is mitigated. There’s no doubt the virus is wreaking serious economic damage (including but not limited to the largest stock market declines in a generation), and there’s cost to waiting before implementing more aggressive fiscal stimulus. Coronavirus will limit consumer spending as workers are forced to stay home, cancel travel, and even lose their paychecks. The new oil price war will take a toll on the nation’s oil industry. A drop in GDP of 2 percent or roughly $400 billion is entirely possible, and maybe more. There’s thus an urgent need for a minimal package of $400 billion of spending and tax cuts for families, and a case for much more. The Obama stimulus came to 5 percent of GDP in 2009, which would equal $1 trillion today. Brookings economists predict a GDP decline of 5 percent in a scenario where there are 589 coronavirus-related deaths.
The president and perhaps some of his advisers seem unaware of this need, and of the fact that the scope of the economic damage will cascade far beyond those specific industries bearing the brunt of immediate job loss. It is folly to underestimate the damage recessions can do, and how a recession takes on a life of its own. Lost jobs and a decrease in business investment have permanent consequences, not temporary ones, and they feed on each other.
Because interest rates are so low right now, reductions in rates have little stimulative impact. The Federal Reserve has wisely injected funds into the financial system to prevent a liquidity crisis, but the central bank has often been unable to stem a decline in GDP. The administration, and some in Congress, appear to fail to grasp how broad-based injections of funding for raising incomes and investments can mitigate the economic downturn. A post-coronavirus recession will last much longer without such intervention, and it has the potential to do permanent not merely temporary damage, as jobs are lost and investment curtailed.
Aside from a poorly targeted travel ban on some Europeans, Trump’s main substantive proposal has been a large cut in payroll taxes. Democrats in the House firmly resist this. Trump says payroll taxes will be distributed quickly. But in fact, payroll tax cuts help workers slowly, not immediately, and a cut would go to better off Americans more than low income workers and would do nothing for those without a paycheck. Payroll taxes are also the source of Social Security benefits, and in today’s political environment, a cut could undermine the system’s solvency.
Trump’s other loosely worded suggestions, such as making loans available to small businesses, providing modest paid sick leave, and deferring taxes do not amount to much stimulus. This has underscored the failure of the administration to quickly ramp up COVID-19 testing that could have thwarted the outbreak.
Even with the Democratic proposals, including an extension and increase in unemployment benefits, Goldman Sachs estimates that stimulative programs will come to only 0.4 percent of GDP, or $80 billion. Federal action is a matter of protecting those most susceptible, but it is also a matter of providing general demand for goods and services to minimize the fall in U.S. incomes overall.
The new compromise between the House and the Trump administration, to be voted on next week, will not likely be enough.
The new compromise between the House and the Trump administration, to be voted on next week, will not likely be enough. One reason is that fiscal policy, which involves federal intervention through tax cuts or more social spending and public investment, has been consigned to the back seat by most mainstream economists for decades now. The mainstream, which includes Republican and Democratic economists, have long argued that monetary policy—the Federal Reserve’s control over interest rates—is the policy tool of choice.
But monetary policy has often been ineffective in the past. In the early 2000s, the Fed led by Greenspan cut its target rates to 1 percent and couldn’t induce an economic recovery from a recession. In the crisis of 2008 and 2009, Fed policy could not save the economy.
Mostly, the analysts who criticized fiscal policy were “small-government” advocates. Milton Friedman had led the charge as early as the 1960s, along with his colleagues from the University of Chicago. Friedman in fact liked tax cuts because it forced the government to cut back. To these economists, more government spending was just a “deadweight loss” to the economy. In their minds, only the private economy could induce growth. Sadly, many Democratic economists eventually bought the argument, in light of anti-government ideology and exaggerated fears over budget deficits.
The real untold history is that in emergencies, fiscal policy came to the rescue. Fiscal policy was the brainchild of John Maynard Keynes, who did his seminal work in the 1930s, but was dismissed by Friedman and his followers. When push came to shove, their conservative ideology was set aside, however, and fiscal policy was called upon to rescue the economy. President Bush ordered a tax cut in the early 2000s and sent money to individuals, President Obama’s $800 billion stimulus brought the nation out of steep recession in 2009 and eased the losses of income to millions of Americans.
Ronald Reagan’s sharp tax cuts in the early 1980s was really a form of Keynesianism, if an excessive one. Even in 2009, the Obama spending package stimulus was limited by Republican fears of a rising deficit. The compromise was to adopt unnecessary tax cuts as part of the package. But the 2009 Recovery Act worked to pull the U.S. out of the deepest recession since the 1930s.
In 2016, the argument among Democratic economists began to support fiscal policy more explicitly. The Princeton economist Alan Blinder wrote a long history praising fiscal policies for the Brooking Institution. Jason Furman, the head of Obama’s Council of Economic Advisers, wrote a piece that year which more boldly declared the need for fiscal policies should add more.
One of the advantages of fiscal policy is that it can be injected quickly into the economy. That is the priority at the moment. The severity of recessions has rarely announced themselves ahead of time, and few economists have accurately predicted one.
Compounding matters, because the coronavirus has spread so quickly, it has not yet shown up in hard data about the U.S. economy. But it will soon, and the nation cannot wait for a government response.
There are automatic stabilizers that will serve as stimulus. As people lose jobs, unemployment insurance payments will increase. As individuals and businesses see profits fall, they will owe less in taxes. Medicaid payments will rise as more people fall into poverty. Food stamp payments should also rise.
Some useful new policies are obvious. Federal mandated paid sick days is one, though Republicans have objected to sensible mandates proposed. Subsidies to corporations to give employees furloughs is another. Importantly, an extension and increase of unemployment benefits should be high on the list. Aid to states to shore up spending on Medicaid and education would make sure those stabilizers work the best.
Some say micro policies are needed, aimed at industries or certain kinds of workers, but this is a more serious recessionary outlook than bad news for some industries or small groups of citizens. More imagination and public discourse is needed. Italy has suspended mortgage payments, for example. Suspension of rents may also make sense.
Jason Furman would give $1,000 to each American and another $500 for each child. George W. Bush did something similar. This would cover all kinds of Americans, from union members to gig workers to those who have no jobs. It also can be spent right away to support the economy.
In his 2016 piece, Furman also argues that it may make sense to have long-term fiscal stimulus to support growth and investment. This may be the best opportunity for Congress to adopt an aggressive infrastructure policy, something Senator Richard Shelby (R-AL) has suggested to the president.
And what of the budget deficit? Odds are far higher that fiscal stimulus will induce more growth and higher tax revenues than tax cuts will. At this point, such policies may well reduce the deficit. Tax cuts will be much less beneficial.
Stale ideological arguments are suppressing needed emergency intervention in the economy. As hard evidence of recession becomes apparent soon, Congress and even the White House may see the light. We will see more next week when Congress votes on a new package. But by then the damage will be underway.