
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.
READER COMMENTS
Shyam Vasudevan
Mar 17 2020 at 11:28am
I agree with a lot of the justifiable anger toward firms that accumulated excessive debt while rewarding equity holders, but shouldn’t the Treasury/Fed provide some sort of financing to these firms to ensure there are jobs for workers to return to? The government should shoulder some of the burden for slamming the breaks (which was necessary).
Scott Sumner
Mar 17 2020 at 5:56pm
The best way to assure there will be jobs is to have a monetary policy that insures adequate NGDP in 2021.
Matthias Görgens
Mar 18 2020 at 11:52am
Creditors are not morally superior to equity owners.
Let’s distinguish between a company and its assets.
Too much debt in your capital structure raises the risk that your shareholders get wiped out and that your bond holders subsequently take over and become the new (equity) owners.
There’s nothing morally wrong nor right with that.
What’s important is a quick and transparent bankruptcy process, like liquidation via auction. So that eg factories can quickly find a new owner and keep producing goods and employing people, no matter what happens to the companies that officially own them.
(That assumes that the only thing wrong was that the old owners took on too much debt. Not that there’s no customers for what the factory is producing. In the latter case, shutting down the factory quickly is the most efficient thing to do.
A new owner could also try to re-organise production along more productive lines. Sometimes that works as well.)
Alan Goldhammer
Mar 17 2020 at 11:54am
“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.”
Some of the companies that will go under are in the energy sector and their production costs are far above the now collapsed world oil price thanks to the Saudis. This was a well documented train wreck waiting to happen and I hope Scott’s junk bond holdings don’t have any of those companies.
The bigger question is how to handle all the small businesses that have been forced to close because of various state decrees. Should they be extended zero interest loans to help them? this is a tough one to call as I’m sympathetic to their plight (all the restaurants and bars are now closed statewide in MD and it’s not clear when they will reopen. There are other retailers who are closing as well based on mall traffic that I saw yesterday.
The only bright side to my equity portfolio is Clorox which is up 30% on the year. Too bad I didn’t have the foresight to buy a lot more in January.
Michael Sandifer
Mar 17 2020 at 1:38pm
How do you feel about loans or other assistance for small businesses that typically just barely get by? An example might be a family-run restaurant, or the local gas station owner who also manages the establishment and clears only $40-50k/year?
Scott Sumner
Mar 17 2020 at 6:01pm
Perhaps something equivalent to the unemployment comp program for workers could be extended to the small business owners, so they can get by until things improve. I’d prefer to avoid loans and subsidies to firms, rather we should directly meet the immediate needs of small business owners, which is money to buy food and pay bills.
If you start bailing out bankrupt firms, where does that end?
Michael Sandifer
Mar 17 2020 at 7:16pm
I agree on larger firms. Larger firms are better able and should plan for tail risk. We want to avoid moral hazard.
Sven
Mar 17 2020 at 2:25pm
Scott, what is the difference between fiscal and monetary operations anyway?
It is often argued that a helicopter drop conducted by a central bank is really fiscal and not monetary in nature. But isn’t this kind of distinction superficial and the real difference is actually only this:
All spending which will eventually be paid by explicit taxes are fiscal policy.
All spending which will eventually be paid by inflation “tax” are monetary policy.
This is fully consistent with the view that monetary policy is actually just increasing or decreasing the stock of money (completely ignoring all distribution effects).
Scott Sumner
Mar 18 2020 at 9:05pm
Sven, Yes, but monetary injections such as QE do not generally lead to an inflation tax, as the money is withdrawn when rates rise above zero.
Market Fiscalist
Mar 17 2020 at 7:45pm
‘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.’
Why does fiscal policy during times of depressed aggregate demand necessarily put a burden on future tax-payers ? Couldn’t any bonds sold to finance the fiscal spending just be bought up by the fed with no necessity to ever raise future taxes to pay off the debt (or just not be financed by bonds at all)?
Scott Sumner
Mar 18 2020 at 9:05pm
Probably not, unless at the zero bound forever.
Thaomas
Mar 17 2020 at 7:53pm
“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.”
Assuming that the Fed does not succeed in keeping NGDP rising on target. 🙂
I agree that the $1000/person is poorly targeted and that a real UI without a look-for-jobs or no work requirement would be better. As for a FICA holiday, it’s never a bad time to cut a capped taxes on wages. And the deficit just means that the Fed will have to buy x billion less in QE from existing holders, assuming they fully offset from the amount they have calculated will keep NGDP on track. If it is failing to meet that target, then the deficit will help a bit.
Thaomas
Mar 17 2020 at 7:56pm
Never worse time for “stimulus?” Now is worse than the deficits produced by the “Tax Cuts for the Rich and Deficits Act of 2017?”
Mike Sax
Mar 18 2020 at 7:25pm
Interesting proposal by Maxine Waters, rather than go through Congress she wants to direct the FED to send out cash payments:
“The Trump administration and congressional leaders rushed on Wednesday to assemble a massive stimulus package aimed at preventing the U.S. economy from plummeting into its worst collapse since the Great Depression, as fears about the coronavirus pandemic brought much of American life to a standstill.
“The administration’s $1 trillion proposed rescue plan, which forms the basis for fast-moving negotiations on Capitol Hill, includes sending two large checks to many Americans and devoting $300 billion toward helping small businesses avoid mass layoffs. Priorities laid out in a two-page Treasury Department document also include $50 billion to help rescue the airline industry and $150 billion to prop up other sectors, which could include hotels.”
“The White House is vetting these proposals with Senate GOP leaders before engaging more fully with Democrats, so the package is certain to evolve in coming days. Democrats, meanwhile, are eyeing their own priorities, largely aiming to shore up safety-net programs and the public health infrastructure, as well as send money directly to American taxpayers, while shunning corporate bailouts. Rep. Maxine Waters (D-Calif.) proposed on Wednesday having the Federal Reserve send $2,000 to every American adult and $1,000 to every American child until the crisis ends.”
https://www.washingtonpost.com/business/2020/03/18/trump-coronavirus-economic-plan/
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