Joe Biden’s $ 1.9 billion package is a risky experiment


How much is the fiscal stimulus too much? The debate on this issue among economists who support the goals of Joe Biden’s US administration has grown fierce. This is not a bad thing: politics should be debated. In this crisis, as in the financial crisis of 2008, the risks of doing too little must be weighed against those of doing too much.

But one thing is clear: The fact that too little stimulus was provided in 2009 does not mean that much more than it needs to be fair today. The policy should be judged on its relevance to current circumstances while recognizing the uncertainties and the balance of risks.

I have no objection in principle to the huge tax expenditures. Indeed, in January 2009I argued that the United States should run a budget deficit of 10 percent of gross domestic product until damaged private sector balance sheets are healed. Shortly after, I argued that we need to learn from Japan if we are to understand the dangers that Western economies face. I also recognized from the start that a pandemic is an emergency, much like a war. The policy was indeed to start on a war footing.

Nevertheless, it is essential to recognize what differentiates a pandemic from a financial crisis or a war. Unlike a financial crisis, Covid-19 will not necessarily create bad debt overhang that could suppress demand indefinitely. Instead, the balance sheets of people who earned well and spent little actually improved. Again, unlike a war, the pandemic does not destroy physical capital. So there is a good chance that the economies will recover really strongly, once the fear of the disease subsides. If so, the dominant part of the planned fiscal policy response should not be so much about short-term relief as it is about “building back better”, promoting a sustained increase in public and private investment.

Line graph of the output gap (difference between real and potential GDP, as a% of potential GDP) showing that estimates of excess capacity are now lower in the United States than in other large, high-income economies

This is the context in which the Debate over Biden administration’s $ 1.9 billion tax package must be understood. This is not a philosophical debate, but a debate about the size, timing and nature of the package. The protagonist was Larry summers, former US Secretary of the Treasury and chief economic adviser to Barack Obama, backed by Olivier Blanchard, former chief economist of the IMF. Both are Keynesians and supporters of the Biden administration. Summers even developed the “secular stagnationWhich justifies the use of fiscal policy.

Summers recently questioned the wisdom of the package in the Washington Post. He argued that stimulus measures equal to 13% of GDP (the $ 900 billion already enacted plus the $ 1.9 billion) “were very important, especially in an economy with extraordinarily soft financial conditions, according to forecasts. of reasonably rapid growth, with public spending needs still unmet. and a very large overhang of private savings. Budget deficits in 2021 on proposed plans will quickly approach World War II record highs as a share of the economy.

Column chart of the latest CPI inflation forecasts in 2021 and 2022 (%) showing that consensus forecasts for inflation are low even in the United States

This is undoubtedly a reasonable concern. The growth of the broad money supply is extraordinary. The IMF forecasts only a slight gap between real and potential GDP in the United States in 2021. It is quite possible that monetary and fiscal expansion on this scale will dramatically overheat the US economy. Against this backdrop, we do not see a significant resurgence in inflation expectations, as excess capacity is expected to persist in the global economy as a whole.

Some analysts seem to regard a sharp rise in inflation as inconceivable because it has not happened for a long time. This is a bad argument. Many once thought that a global financial crisis was inconceivable because it had not happened for a long time. In the 1960s, many thought that the inflationary surge of the 1970s was just as inconceivable.

Line graph of US bond yields and inflation expectations (%) showing that expected US inflation has risen, but at non-threatening levels

Many now seem to believe that lower unemployment will not increase inflation. But at some point, excess demand will certainly increase prices and wages. At that point, inflation expectations will start to move permanently upward. The 1970s and 1980s taught us that reducing them again is very costly, not only economically but also for the credibility of the government.

These concerns should not be taken as an argument against any other US budget package. But if Biden could ignore the political timing, it would make more sense to go for a smaller support package now and come up with a huge medium-term investment program later. In the meantime, he will see how the recovery went before proposing another short-term support program. But the administration’s point of view is clearly that it has a window of opportunity to change people’s lives and therefore needs to “act big” now, not later. He also clearly thinks that the balance of risk lies much more in doing too little than in doing too much. Hopefully, her judgment of promoting this huge package turns out to be correct.

Line chart of S&P Goldman Sachs commodity indices, rebased (January 1, 2007 = 100) showing commodity prices are rising, but not yet to spectacular levels

What is clear is that a big package will be even bigger for the eurozone, where the economic impact of Covid-19 on GDP has been worse than in the United States and the recovery certainly looks weaker . Nor is it an argument against shifting the balance of stimulus measures from monetary policy to fiscal policy. Such a change is desirable, since aggressive monetary policy tends to encourage excessive risk-taking in finance.

If passed, the $ 1.9 billion package will be a risky experiment. It might not be a bad thing if it were a little smaller than the one on offer now. Either way, one point is clear. The success of the whole is of paramount importance. Proving that an active government can deliver good things to the public is essential to the health of America’s democracy. I pray that the bet of the Biden administration succeeds.

martin.wolf@ft.com

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