The US Congress is doing what it does best: Throwing money at a problem.
In the last month, US lawmakers have approved some $2 trillion in relief. The money has gone to workers and businesses, to airlines and hospitals, to buy healthcare equipment and to launch a long-overdue national coronavirus testing program.
The cost of this effort dwarfs the combined cost of the rescue programs that followed the 2008 financial crisis. The 2008 bank bailouts and the 2009 stimulus act together cost about $1.5 trillion on paper, though final outlays were significantly less thanks to repayments from the financial sector. Yesterday, the Congressional Budget Office forecast the 2020 deficit to be $3.7 trillion; as a share of the US economy, it’s the highest since 1945, the peak of World War II.
That has some people wondering whether the US can safely borrow all the money it needs to get through the pandemic without risking adverse economic consequences, like rising inflation or interest rates. Republican Senate majority leader Mitch McConnell is now saying the additional national debt is a “a matter of genuine concern.”
Talk to economists, though, and you’ll hear a different story: The US can afford to spend, and indeed must, at least for now.
Beyond helping Americans survive in the near term, the say government spending will make sure that as the economy grinds to halt to slow the spread of coronavirus, it will be easier to restart again when the time comes. The idea is that if workers have money to pay bills and avoid bankruptcy, and if stores and factories can avoid closing entirely, then the recovery will be faster.
A green light from markets
The money in question will be borrowed from investors around the globe through debt issued by the Treasury Department. Is there any limit to that borrowing?
“The way you get in trouble with government spending is you are crowding out private investment, or you basically spook everybody so they start pulling their money out of the economy,” explained Adam Posen, the president of the Peterson Institute for International Economics and a former member of the Bank of England’s monetary policy committee.
For Posen, neither of those risks loom large at the moment. Economists have been fretting about low private investment and high savings for years now, so blocking private investment isn’t a major concern.
Investors don’t appear worried about the value of the dollar either. While putting more money into the economy could lead the value of the dollar to fall, all things are not equal: The economy is running below its capacity and demand for assets recorded in dollars is only rising. “The dollar keeps winning the least ugly contest,” Posen said. “Everyone else is getting uglier at least as quickly.”
Indeed, last year, outgoing American Economic Association president Olivier Blanchard, a former chief economist at the International Monetary Fund, delivered a lecture arguing that the costs of debt are far smaller than commonly believed. Part of his reasoning is that the US only refinances a small portion of its debt at any given time, allowing it to lock in low interest rates and giving policymakers time to react if they rise.
Two bets
The confidence of Posen and other economists in the US ability to avoid adverse consequences from its borrowing depends on two key factors: A belief that if inflation does start to increase, an independent Federal Reserve will raise interest rates, and that if push comes to shove, Congress will be willing to raise taxes.
The Fed, as it did after the last financial crisis, has begun backstopping the US Treasury market by purchasing US government debt from private investors. Some critics consider this “monetizing” the debt—that is, allowing lawmakers to spend without restriction. But Fed officials argue that this is an effective way to protect financial markets from disruption and stimulate the economy when interest rates are already at zero.
“People at some point have to take seriously the fact that Japan has been running huge deficits and the central banks have been buying bonds for 25 years and there has been no inflation and no runs on the Yen,” Posen said. In other words, the funding possibilities for advanced economies may be larger than many believed in the past.
And yes, there’s a meme for that: “Watch the money printer go brrrrr.”
Some are less sanguine. Sheila Bair, a former chair of the Federal Deposit Insurance Corporation, says the Fed is right to deploy its financial powers now, but said on Twitter that “we should not be overconfident about the longer term stability implications of current Fed actions…There aren’t many Paul Volcker’s around,” referring to the Fed chair who raised rates and ended the “stagflation” of the 1970s.
And what about raising taxes—will that ever happen with US Republicans fanatically opposed to them? The passage of two largely bipartisan aid bills in the last month is a signal that when push comes to shove, the parties can get something done. Even centrist Democrats like Robert Rubin, a bête noire of progressives because of his conservative approach to fiscal policy, has called for tax increases after the crisis, a signal that Democrats may have less internal dissent and more leverage.
It’s worth noting that the widely panned 2017 tax cut enacted by the Trump administration cost almost as exactly as much as the CARES Act, at a minimum $1.8 trillion.
A way forward
“If this is genuinely a once in a generation event like a serious war, then we’ve got plenty of space to do it,” Posen said. “If we think there’s going to be a pandemic every couple of years of this nature, we have to do a rethink.”
The Congressional Budget Office (CBO) is forecasting a deficit equal to 17.9% of GDP in 2020. That isn’t sustainable over time. But it doesn’t mean the US needs to enter austerity mode in 2021.
One thing economists stressed during the last crisis, and are again underscoring now, is the importance of automatic stabilizers, which are programs like food stamps or unemployment insurance that spring into action when people need them and recede when they don’t.
They are more effective in a crisis because they don’t require lawmakers to go through the slog of passing and implementing a new program—just look at how long it took to make emergency small business loans available through the Paycheck Protection Program, and how the cap on its funding forced another delay while lawmakers added more money to the pot.
“Fundamentally, we can afford making permanent a lot of the things we are doing on a temporary basis in terms of better unemployment benefits, better emergency credit for small business, better support for state and local government,” Posen said.
If the economy returns to some semblance of normal next year through a combination of growing immunity, better anti-viral treatments or a new vaccine, Posen sketched out a path to sustainability: Spending on economic support will naturally fall and tax revenue will rise as people go back to work—the CBO expects the deficit in 2021 to shrink to about 9.8% of GDP absent no other action.
The government can then raise taxes by 2% of GDP or more a year without harming the economy. And then, Posen said, if it wasn’t obvious before the pandemic, it’s clear now that there is much to be done to improve the US healthcare system and reduce its costs.
Anyone familiar with the US congress knows that such plans are easier said than done. But from an economics point of view, it’s all quite feasible.
The heterodox path
That’s all relying on what we might call “traditional economics.” In recent years, economic thinkers have developed even more ambitious ideas—flying under the banner of Modern Monetary Theory—which suggest there is even less of a need to worry about the deficit.
Stephanie Kelton, an economist at Stony Brook University, has written a forthcoming book called the “Deficit Myth,” whose title neatly sums up her argument that economies with their own currencies don’t need to worry about borrowing money as long as their economies can use the money in useful ways—and there are plenty of useful things to do with money right now.
Two progressive lawmakers have even introduced a bill calling on the Treasury to mint $1 trillion platinum coins and deposit them at the Fed to finance the pandemic response, an idea that emerged amid the fiscal debates following the 2008 financial crisis. The platinum coin is something of a gimmick that makes fiat money more tangible, but many economists remain skeptical of it as a real solution.
Posen didn’t want to get into platinum coin theory, but he says that getting lawmakers to recognize that the Fed’s asset purchases—an effective analogy to the coins—can be a useful tool is at least worthwhile.