Will Joe Biden’s fiscal stimulus overheat the US economy? Economist analysis
What should we expect from Joe Biden's tax plan? The Economist's analysis
Joe Biden enters the White House for the second time during an economic crisis. On January 14, he presented his plan to tackle the recession caused by the pandemic. Seen from the bottom up, it is a combination of vital expenses for vaccines and health care, necessary financial aid and other more questionable handouts. Seen from top to bottom, it is a huge debt-financed stimulus. Biden's plan is worth about 9% of pre-crisis GDP, almost double the spending package of President Barack Obama in 2009. And it is big, also in relation to the likely drop in demand that America could expect to suffer from. once the winter wave of covid-19 has been left behind, and given the stimuli already in place – writes The Economist.
A natural question to ask, then, is whether the proposal, while being an opening move in a deal with Congress, could overheat the economy. The most prominent figure who warns that this could happen is Larry Summers of Harvard University. His criticisms are notable both because he was an adviser to Obama and because he was perhaps the most prominent deficit-spending proponent in the world so far. "If we leave fear behind, we will have an economy on fire," he said on January 14.
There are three main reasons to suspect that overheating could be in the cards: emerging evidence that the recession could prove temporary, generous stimulus, and the Federal Reserve's monetary policy strategy. Let's first take evidence that today's recession may be more of a temporary hiatus than a prolonged slump. The number of non-farm jobs remains 10 million, or 6.3%, below its pre-pandemic peak, similar to the decline in 2010 at the worst of the last crisis. Yet, after the first wave of infections in 2020, unemployment fell far more rapidly than experts expected. If job creation were to return to the average pace reached between June and November 2020, the pre-pandemic employment peak would be regained in less than a year. Only in the middle of Biden's second vice-presidential term was such a milestone reached last time.
Confirming a rapid rebound is the fact that economic disturbances appear to be concentrated in some sectors, rather than widespread on a large scale. America lost jobs online in December, but only because the leisure, transportation and hospitality industries were decimated by social distancing. The ratio of job openings to unemployed workers remains high and, outside the sectors concerned, wage growth has not declined much. The spending deficit is equally concentrated. Consumer spending in the week through January 3 was only down 2.8% from the previous year, according to Opportunity Insights, a research group. Yet retail spending on goods increased by 16.5%; it's restaurants and entertainment that are in trouble. And fiscal stimuli more than offset the drop in incomes in 2020. In November, the last month for which official data are available, Americans' total after-tax income was 4.3% higher than the year. previous one.
Indeed, stimulus arithmetic is a second reason why the economy could heat up. Before December, total fiscal stimulus in 2020 amounted to nearly $ 3 trillion (around 14% of GDP in 2019), far more than the likely decline in production. Social distancing measures have meant that much of this liquidity has accumulated in bank accounts. According to Fannie Mae, a government-backed housing finance company, Americans had accumulated about $ 1.6 billion in excess savings by mid-December. It is difficult to know what could happen to this pile of money; Economists usually assume that households are much less likely to unexpectedly spend wealth (such as a rise in the stock market) than income. But if people consider these excess savings to be delayed income, then the hoarding of money represents a stimulus that has not yet met, to be used when the economy fully reopens.
In December, President Donald Trump signed another bill for $ 935 billion in deficit spending, which extended unemployment benefits, provided more support for small businesses, and sent most Americans a check for $ 600. dollars. This ensured that the lost income continued to be replaced. Biden's $ 1.9 billion stimulus proposal, which includes another $ 1,400 in checks, would make the total fiscal boost in 2021 roughly equal to that of 2020.
Jason Furman, another former Obama adviser, estimates that the combined impact of the December package and the Biden plan would be about $ 300 billion per month for the nine months of 2021 for which the measures are in place. By comparison, the decline in GDP, compared to the pre-crisis trend, was only about $ 80 billion in November. Typically, Keynesians argue that fiscal stimulus stimulates the economy due to a large "multiplier" effect. But the case that the stimulus is as big as Biden's proposal "must be that the multiplier in 2021 is thought to be very small," says Furman. Otherwise, it looks set to push the economy's total spending beyond what it can produce next year, causing an explosion in inflation.
If the economy were to show signs of such overheating, the Fed could be expected to raise interest rates to cool things down. Indeed, since January 6, when Democrats won crucial Senate seats in Georgia that could allow them to pass a major stimulus, the 10-year Treasury yield has risen from about 0.9% to about 1, 1%. Yields on inflation-linked bonds rose roughly, suggesting that investors were expecting higher real interest rates rather than higher inflation.
But the Fed is tripping over itself to signal that monetary policy will remain loose – a third reason to expect overheating. The time to raise interest rates is "not soon," said Jerome Powell, its president, on Jan. 14. He also hinted at the idea that the Fed may soon reduce its monthly purchases of Treasury and mortgage-backed securities by $ 120 billion. Powell said the central bank learned its lesson from 2013, when hints from the Fed that it could cut asset purchases sent bond markets haywire. Monetary policy makers continue to say that preserving the "smooth functioning of the market" is one of the objectives of these purchases, despite the fact that there have been no malfunctions in the bond markets since spring.
The Fed is so willing to keep the accelerator pedal because, in contrast to the recovery from the financial crisis, it is trying to exceed the 2% inflation target, to compensate for continuing deficits. The strategy, announced last summer, is still being digested by investors. It is unclear whether policymakers are committed to "targeting average inflation" as an end in itself, or simply as a means of preventing inflation expectations from slipping too far during the crisis, says David Mericle of Goldman Sachs, a bank. Given that inflation expectations have risen recently, this distinction could prove important. In any case, the Fed has been clear that it will not raise rates until inflation is "on track to moderately exceed 2% over a period of time."
Those zealously committed to getting the world economy out of the low-rate, low-inflation trap of the 1920s may welcome the even greater inflation explosion that the current mix of fiscal and monetary policy could allow. The Fed, however, is not in that field. If overheating results in rate hikes earlier than markets expect, the low-cost borrowing that underlies the current skyrocketing asset prices and rising public debt sustainability could begin to unravel.
Such a scenario remains a more remote risk. The most likely outcome is that Congress agrees on a smaller stimulus than Biden's proposed and that overheating, if it does occur, will prove temporary. Beyond that, no one really knows how fast the economy can grow without triggering inflation. If economic policy were to remain in uncharted territory, however, its speed limits could be tested more frequently.
Article taken from the foreign press review of Eprcomunicazione
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/lo-stimolo-fiscale-di-joe-biden-surriscaldera-leconomia-americana-analisi-economist/ on Sat, 23 Jan 2021 06:49:39 +0000.