Words of caution about recovering from our coronavirus recession
President Trump’s signing of the CARES Act on March 27 sealed large fiscal support for a U.S. economy reeling from the economic aftershocks of the COVID-19 pandemic. While that law’s budgeted cost of more than $2 trillion is jaw-dropping — and while Congress is now arguing over what to include in another recovery bill, this one of $250 billion to $500 billion — the intervention itself is an essential step to halting a free-fall in economic demand.
It demonstrates an essential role of the federal government to prevent economic meltdowns in catastrophes or wars — but it also reminds us of the need to maintain future fiscal strength and flexibility.
Concerns over the budget cost of ameliorating economic costs associated with shutting down large segments of the economy in response to the pandemic are understandable. The amounts already budgeted and still being discussed far exceed any “stimulus” spending associated with previous downturns, including the recession falling out of the 2007-2009 financial crisis.
But here’s the rub: Properly understood, the economic recovery spending may not be outsized. It also should not be interpreted as “stimulus.” And the recession around the corner is not the recession that policymakers are accustomed to fighting. Understanding these points is key to guiding macroeconomic policy now and in the near future.
First, the level of spending and new debt. Judging a $2 trillion recovery cost (a figure likely to become even larger) requires a counterfactual: What are the economic and budget costs of doing nothing? Given the sudden stop of economic activity imposed by the health-related shutdown, those costs are large in terms of widespread layoffs from and failures of revenue-starved businesses, particularly small and mid-sized firms. Laid-off workers would receive unemployment insurance benefits and, potentially, Medicaid benefits, and the sharp decline in aggregate demand associated with unemployment and business failures will reduce federal — as well as state and local — tax revenue. The pandemic itself is an aggregate supply shock, one hopefully ameliorated by the economic shutdown. That amelioration leads to a decline in aggregate demand, a decline which can turn into a long-lasting “doom loop” if layoffs and failures persist. Stopping the doom loop in its tracks requires bold fiscal action.
Measuring the cost of the recovery law against “stimulus” measures is not an apt comparison. Stimulus seeks to get consumers or businesses to spend more, given a shortfall in aggregate demand. Such efforts are an integral part of countercyclical fiscal policy and shape policymakers’ views of action. But a few short weeks ago, the U.S. economy was in good shape, with GDP growth in the range of estimates of potential growth and a tight labor market with a low rate of unemployment. The need for fiscal support is not about getting households to spend. Instead, it is to shore up household and business incomes and balance sheets to forestall a future vicious cycle of declines in aggregate demand. Simulating as much as possible the income flow of a normally functioning economy, while the appropriate shutdown occurs, should be the goal of a fiscal response.
Importantly, this coming recession is not a typical recession. It bears more in common with a large-scale natural disaster (during which such economic effects usually are more regional than national) or a war (as in large-scale prolonged combat — think the beginning of World War II, or the terrorist attacks of Sept. 11, 2001). In such episodes, a shutdown in many normal areas of economic activity may be required for a period. In addition, resources may need to be diverted across economic activities — for example, production of ventilators instead of automobiles, or hand-sanitizer instead of distillery bourbon.
Whether the recovery package is sufficient to halt an aggregate demand “doom loop” of continuing layoffs and business closures depends in large part on the length of the economic shutdown required to slow the spread of the pandemic. A much longer period of social distancing and closures will require continued intervention to fill portions of lost incomes and preserve attachments of employees and many businesses. Such preservation avoids current and longer-run costs of unemployment and business shutdowns. But it will continue the large increase in federal spending and borrowing.
Two big lessons about fiscal policy emerge here.
The first, from before, is that the large temporary government intervention in this crisis is a good example of government social insurance in a catastrophe or wartime spending. As with a war, this one-time intervention will raise debt, but that debt-to-GDP ratio, all else being equal, will fall over time once growth resumes. Second, particularly with elevated debt levels, it is important to avoid creation of new long-term social spending or expansion of existing entitlement programs. Those changes both fail the arithmetic of a one-time change in debt to preserve the economy in a pandemic and fail our ability to use debt this way in a future crisis.
Glenn Hubbard, Ph.D., is dean emeritus and the Russell L. Carson Professor of Finance and Economics at Columbia University. He was chairman of the Council of Economic Advisers under President George W. Bush. He has written more than 100 scholarly articles on economics and finance, is the author of three textbooks and co-author of five other books, including “Balance: The Economics of Great Powers, from Ancient Rome to Modern America” (2014).
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