There's never been a worse time for fiscal stimulus
We are now seeing renewed calls for fiscal stimulus. This is a terrible idea.
Let’s start with proposals to build infrastructure. Boston recently shut down its entire construction industry, and other cities are likely to follow. Eventually, construction will once again be allowed. But at that point new projects will need to go through the environmental impact statement process, which takes many years. This sort of fiscal stimulus would likely occur long after the epidemic has passed.
It is true that the economy currently faces a demand shortfall, but this can be addressed much more effectively with monetary stimulus. As I pointed out in a recent post, the Fed hasn’t even scratched the surface of what it can do to boost aggregate demand. Monetary stimulus is far more efficient than fiscal stimulus, because it does not put a burden on future taxpayers in the form of higher debt.
There’s also a humanitarian argument for government aid, as many people work in industries that will be severely impacted by the coronavirus. Most of the proposals that I’ve seen, however, do little to address this problem. A payroll tax cut would only help those who are working. But full time workers (like me) will actually see their real incomes rise during this crisis, as prices for everything from gasoline to mortgages falls sharply. Mitt Romney proposed having the federal government give each American $1000. But most Americans will not lose their job, and don’t need this sort of “welfare”.
Instead of blindly throwing money at the problem, we need a smart response to the coronavirus epidemic. It would contain the following components:
1. An immediate shift by the Fed to level targeting, combined with a commitment by the Fed to buy whatever it takes (of any asset necessary) to quickly return to its price level (or NGDP) target path after the immediate crisis is over.
2. Fiscal programs strictly targeted to meet humanitarian needs, such as extending the unemployment compensation program beyond 26 weeks if the coronavirus epidemic lasts for more than 26 weeks. Perhaps the weekly payments could also be boosted during this crisis, as the “moral hazard problem” is secondary for the immediate future. Extra spending should be paid for with a higher payroll tax on upper income salaries.
Fiscal policy over the past few years has been perhaps the most reckless in all of American history, with an exploding budget deficit even as unemployment falls to 3.5%. The budget deficit is already over a trillion dollars; we certainly don’t need more deficit spending right now.
3. There should be no bailouts of bankrupt firms, except perhaps in extreme cases of essential services. People that bought junk bonds (like me) should accept their losses. That’s how capitalism works.
I doubt that we will be smart. Monetary policy will probably do far too little. Fiscal policy will try to do far too much, and fail to achieve its objective. But I am hopeful that this crisis will lead the Fed to re-evaluate its approach to monetary policy and institute some long needed reforms. The recent elimination of reserve requirements was a tiny first step.