It wouldn’t be bad if the US fiscal stimulus ended up being a little less than currently proposed

Illustration: James Ferguson

By Martin Wolf / Published in English in the Financial Times on 2/23

How Much Fiscal Stimulus Is Too Much? The debate on this issue among economists who support the goals of the US administration of Joe Biden has become intense. That’s not bad: politics should be debated. In this crisis, as during 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 distributed in 2009 does not mean that much more than that must be the right thing to do today. The policy must be judged on its suitability in current circumstances, while acknowledging uncertainties and the balance of risks.

Theoretically, I have no objection to huge tax expenditures. In fact, in January 2009, I argued that the US should have run a fiscal deficit of 10 percent of gross domestic product (GDP) until damaged private sector balance sheets recovered. Soon after, I argued that we had to learn from Japan if we were to understand the dangers facing Western economies. I have also recognized from the beginning that a pandemic is an emergency, rather like a war. In fact, politics needed to be on the warpath.

However, it is critical to recognize the difference between a pandemic and a financial crisis or war. Unlike a financial crisis, Covid-19 will not necessarily create excess private bad debt that is likely to suppress demand indefinitely. Rather, the balance sheets of people who have earned well and spent little have improved. Again, unlike a war, the pandemic does not destroy physical capital. Economies are therefore very likely to recover with real strength once fear of disease has subsided. If so, the dominant part of the planned fiscal policy response should be directed not so much towards short-term relief but more towards “building back better”, promoting a sustained increase in public and private investment.

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This is the context in which the debate over the Biden administration’s $ 1.9 trillion tax package must be understood. It is not a philosophical debate, but one about the size, timing and nature of the package. The protagonist has been Larry Summers, former US Secretary of the Treasury and main economic adviser to Barack Obama, supported by Olivier Blanchard, former chief economist of the International Monetary Fund (IMF). They are both Keynesians and supporters of the Biden administration. Mr. Summers even developed the “secular stagnation” theory, which justifies dependence on fiscal policy.

Mr. Summers recently questioned the wisdom of the package in an article in the Washington Post. He argued that the stimulus equivalent to 13 percent of GDP (the US $ 900 billion that had already been enacted plus the US $ 1.9 trillion) “was very large, especially in an economy with extraordinarily relaxed financial conditions; with reasonably fast growth forecasts; with public spending needs not yet met; and with a huge excess of private savings. Budget deficits in 2021 in the proposed plans will quickly approach World War II record levels as a portion of the economy. “

This is undoubtedly a reasonable concern. The growth in the expanded money supply is extraordinary. The IMF has forecast only a small gap between real and potential GDP in the US for 2021. Monetary and fiscal expansion on this scale may well overheat the US economy. Against this, we do not see a significant resurgence in inflation expectations, while excess capacity is likely to persist in the world economy as a whole.

Some analysts seem to view a significant rise in inflation as inconceivable because it hasn’t happened in a long time. This is a bad argument. Many once thought that a global financial crisis was inconceivable because it hadn’t happened in a long time either. In the 1960s, many thought that the inflation spike of the 1970s was equally inconceivable.

Today, many seem to believe that lower unemployment will not increase inflation. But, at some point, excess demand is sure to push up prices and wages. At that time, inflation expectations will start to move permanently higher. The 1970s and 1980s taught us that reducing them again is very costly, not only economically, but also in terms of the credibility of the government.

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These concerns should not be taken as an argument against any other US tax package. But if Mr. Biden could ignore the political moment, it would make more sense to opt for a smaller support package now and propose a large medium-term investment program later. In the meantime, he could see how the recovery was going before proposing another short-term support program. But the management point of view is clearly that it has a margin of opportunity to alter people’s lives and therefore must “act big” now and not later. The administration also clearly believes that the balance of danger leans more toward doing too little than doing too much. We must hope that the decision you are making in promoting this huge package turns out to be the right one.

What is clear is that a large package will be even more important for the eurozone, where the economic impact of Covid-19 on GDP was worse than in the US and where the recovery seems likely to be weaker. This is also not an argument against shifting the balance of stimulus from monetary to fiscal policy. Such a shift is desirable, given that aggressive monetary policies tend to promote excessive risk-taking in finance.

If enacted, the $ 1.9 trillion package will be a risky experiment. It wouldn’t be bad if it ended up being a bit smaller than currently proposed. Regardless of what is decided, one point is clear: the success of the package is of immense importance. Showing that active government can deliver good things to the public is essential to the health of American democracy. I really hope the Biden administration gamble succeeds.

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