This tweet identified the real issue:
People often talk about the risk of economic overheating, but that seems unlikely. TIPS market participants seem to agree, as that market also forecasts close to 2% inflation going forward.
The actual risk is that a very large fiscal stimulus package will not stimulate the economy (at the margin), as the Fed will offset the effect. (Just as the Fed offset fiscal austerity in 2013). Instead, we will merely add to the national debt.
Given low interest rates, there’s a respectable economic argument for a slightly higher steady-state budget deficit, and some of the fiscal package may be useful. But quickly dumping $1.9 trillion into the the economy is almost certainly not a policy that minimizes the long run deadweight cost of taxes. I’d encourage policy makers to take a deep breath and think about their long run objectives. What are they actually trying to accomplish, and what’s the most cost effective way of getting there?
And think at the margin.
PS. I began blogging on monetary offset back in 2009. Expect to see a lot more discussion of this issue in the years ahead.
READER COMMENTS
Thomas Hutcheson
Feb 7 2021 at 6:41am
Fiscal “stimulus” only stimulates when the Fed is constrained for some reason or another in the amount of additional debt it can purchase and the additional federal debt relieves that constraint. I think this was a good description of 2009-20, but not early 2021. Just look at the TIPS.
This does not necessarily mean that the relief bill is too big, but it does mean that there are few free lunches in there. Each item needs to pass its NPV test with no “help” from assuming that the marginal cost of inputs are less than financial costs. Transfers need to be carefully thought out: what is the consumption level of the recipient of the marginal dollar transferred in relation the that of the marginal taxpayer.
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Scott Sumner
Feb 7 2021 at 12:36pm
If the Fed was constrained during 2009-20, how was it able to successfully offset the 2013 fiscal austerity?
Thomas Hutcheson
Feb 7 2021 at 8:52pm
That is a good question. We clearly do not know just how the constraint worked. Maybe is was some kind of operational inflation target that was less then the stated target which did not constrain it from offsetting a lower deficit.
Someone with political science of group psychology expertise should try explaining Fed behavior up until August 2020.
Scott Sumner
Feb 8 2021 at 3:01pm
Or maybe there was no constraint.
Josh B
Feb 8 2021 at 11:02pm
It’s worse than that: if the Fed offsets, that leads to higher interest charges on the governments enormous debt.
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