Stimulus is today’s economics buzzword. With a new administration in Washington, amid an accelerating rollout of mass vaccinations, policy discussion in the US revolves around the size of the next fiscal package. Similar debates are taking place across the world. But the word “stimulus” is causing a lot of confusion. The focus on the mere size of the next plan draws attention away from what is actually going on in our economies.
In many ways, stimulus is beside the point. The key words ought to be support and shift — support in the short run for those worst affected, and the shift of resources that will be needed later, once a successful vaccination program (not to be taken for granted) has been largely completed.
The reason for this is straightforward: None of the major economies have experienced a normal business-cycle downturn nor can expect a normal bounce-back. Output has fallen because of government-mandated shutdowns and decisions by households to protect themselves by not going out to work and spending as usual. It would be odd for a government to curtail economic activity for reasons of public health while at the same time trying to boost activity with monetary and fiscal stimulus. Central banks and governments have got themselves into a tangle because of a failure to be clear about the nature of the problem.
The case for a large fiscal response — “going big” — is not to stimulate spending but to enable businesses and the self-employed to survive while maintaining employment. In Europe that support has been provided through furlough schemes and in the US by relief for the unemployed and other transfers. Such support will be required until we escape the fear of large numbers of deaths from Covid-19, with all restrictions lifted and confidence largely restored.
Nobody can really know when that will be. The discovery of new mutations of the virus should remind us that, with every twist and turn of the Covid saga, events have not turned out as governments had expected. Economic forecasts made at this time last year proved worthless.
The difference between stimulus and support should shape the policy response. Last March, central banks purchased large quantities of assets to prevent dislocation in normally liquid markets for government instruments. But those purchases were not reversed when the temporary dislocation ended. The result is that, unlike after the quantitative easing undertaken in response to the financial crisis, monetary aggregates are now growing very rapidly. In the US M2 rose by 26% between January 2020 and January 2021; in the UK the broader measure M4 rose by over 13% in the year to December 2020.
The belief that the sharp fall in output over the past year is a reason for a large monetary injection reflects a fallacious view that any kind of negative shock justifies stimulus. The economic models that lie behind that view fail to pay adequate attention to the nature of today’s shock. Further generalized monetary and fiscal stimulus would add to the existing risk of much higher inflation down the road.
On the fiscal front, what’s required is temporary support for those affected by the immediate consequences of Covid-19, not a longer-lasting stimulus. This is the crucial distinction, far more important than whether the package is big or small.
Much has been made of the difference between the size of the Biden administration’s proposed package and the degree of stimulus recommended by its critics. In fact, both Treasury Secretary Janet Yellen and former Treasury Secretary Larry Summers are right. It makes sense to go big with temporary support that will unwind as the Covid restrictions are relaxed — just as Yellen advocates, when she stresses the need to help people “make it to the other side.” But Summers is also correct in pointing to the dangers of a longer-lasting fiscal stimulus on top of the Federal Reserve’s large monetary injection.
The debate should be about the timing and composition of added fiscal support, not about whether it adds up to $1.9 trillion, $600 billion, or something in between. Support, not stimulus, is what’s critical in limiting the damage from the Covid restrictions while avoiding future inflation. And once that’s settled, we can start talking about the next big challenge — guiding the long-term shift in economic activity that will be needed after the pandemic is controlled. I’ll come back to that next time.
(Bloomberg)
