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Why the White House Should Propose More Economic Stimulus
While a wait-and-see approach is usually wise, unusual times require unusual playbooks, writes a former Trump administration economic advisor.
U.S. economic officials now face the fog, if not of war itself, then at least of something like it. President Donald Trump has declared a “big war” on the coronavirus. Federal Reserve Chair Jerome Powell has spoken of an “unusual, new kind of uncertainty added on top of our regular uncertainty.”
Amid today’s fog, familiar winds of debate howl about the size and speed of economic stimulus legislation. Some people, favoring action, argue that additional spending would avert a deeper downturn and prolonged recovery. Others worry about raising budget deficits or inflation. In normal times, in a normal downturn, familiar principles of economics would apply. But these times are not normal. Nor is this downturn. Familiar principles of economic policy may now lead U.S. officials dangerously astray.
Economists have analyzed the implications of “true uncertainty” ever since the University of Chicago’s Frank Knight first distinguished it from what we know as calculable risk in 1921. A rich body of research about decision-making in the presence of uncertainty has since developed. Economists—including those who, like myself, have served in the Trump administration—continue to make its acquaintance.
Principles for decision-making under uncertain circumstances rather than traditional macroeconomics should now guide the response of U.S. economic officials to the coronavirus contraction. In the unprecedented circumstance of unemployment rising to the highest rates in living memory, businesses and entire sectors shutting down, and no real timeline for activity to return to normal, the pursuit of a perfect solution becomes futile—and should be abandoned. To err, one way or another, is now inevitable. And so officials should base decisions on the likely ramifications of one type of error versus another, steering the ship of state away from the graver dangers.
Amid the haze, this new calculus of navigation shines a light on the right course of action: erring towards more rather than less stimulus, and sooner rather than later. To err in the direction of inaction now is to risk irreversible human and economic catastrophe. Focusing on action risks the limited downsides of higher budget deficits and inflation. The White House can embrace this approach while disagreeing, strenuously, with the contents of the draft stimulus legislation passed by the U.S. House of Representatives. There is even a political opportunity for Trump by offering a bailout of Main Street to contrast with the Wall Street bailouts during the last financial crisis in 2008.
There are likely staggering human costs of a tepid, prolonged recovery that resembles the Nike “swoosh” logo—with its long right-hand side—rather than a relatively robust, quick, V-shaped recovery. According to one set of estimates, a U.S. recovery that ends in 2029 rather than 2023 may come with as many as 110,000 more deaths from suicide, alcoholism, and drug abuse. Based on these estimates, even a modest raising of the rate of recovery towards a V-ending in 2023 would avert tragedy for thousands. While the mechanisms are poorly understood, unemployment appears also to raise rates of ailments such as cancer and heart attacks.
A deeper recession would also scar U.S. consumers. And those scars last. People who live through temporary bouts of high unemployment tend to spend less—forever—as beliefs that influence spending habits permanently change. Coronavirus is already attacking the mind of the U.S. consumer: Even long-term economic expectations are in free fall. And negative shifts in belief dampen spending regardless of future incomes. Deeper downturns displace more workers, whose permanent income losses infect even their children’s future selves. A lengthier recovery also hurts a generation of college graduates, reducing their incomes. Worse, these reductions in income tend to manifest in ways that exacerbate existing inequalities. The legacy of a longer recovery and deeper recession would be a U.S. economy with a tapestry of scars on its consumers.
The downside risks on the supply side of the economy are no less grim than on the demand side. As Neil Irwin of the New York Times pointed out, every business embodies a complex web of relationships—between customers and brands, suppliers and purchasers, employers and employees—that can be rebuilt only with time, if at all. The full extent of the void left by the closure of the legendary Manhattan bar where Hamilton writer Lin Manuel-Miranda once serenaded a stranger, for instance, is unlikely to ever be filled.
The novel coronavirus may even produce a novel economic pathology that eliminates a typical upside of downturns—that of eliminating inefficient businesses. The unusual nature of the pandemic-induced shutdown could instead lead to the end of otherwise successful businesses and models.
The downsides of inaction, then, include thousands of lives lost alongside structural damage to both the demand and supply sides of the U.S. economy. Meanwhile, the costs of higher federal budget deficits that would accompany any new stimulus are likely lower than at any point since 1945. Budget deficits decrease the net wealth of the United States when foreign buyers purchase the U.S. Treasury debt that funds them. But the Federal Reserve is poised to buy new U.S. Treasury debt on a scale unseen since World War II. The profits on the Federal Reserve’s bond portfolio, including U.S. Treasury bonds, are remitted back to the U.S. Treasury. If past wartime experience is any precedent, the U.S. central bank will then hold onto the bonds from birth until they mature and die.
An expansion of the central bank’s balance sheet, in principle, risks accelerating inflation in the United States by printing money. As the U.S. economy officially experiences a bout of deflation, however, bond markets imply average inflation of slightly more than 1 percent over the next 10 years —less than half of the 2 percent target of the Federal Reserve. An acceleration of inflation beyond 2 percent may therefore not even be a problem. Yes, a return to rates of inflation unseen since the 1980s would come with serious side effects that harm some Americans, such as retirees who rely on savings, more than others. But a flip side of the United States’ persistent trade deficits is that foreigners hold many of the claims on future U.S. income—the U.S. equity and debt investments—that would bear much of inflation’s burden. The U.S. dollar’s role as the global reserve currency may even mitigate the losses of foreign investment that often accompany bouts of inflation. To be sure, debt issuance is never cost-free. The U.S. Treasury likely needs to raise future tax rates to fund additional debt payments, lowering household incomes in the future. But future households would also benefit from the higher incomes that would accompany the avoidance of permanent scars to the U.S. economy. As Powell recently underscored, deficits are never free—but they are now worth the cost.
White House officials, for their part, have indicated a data-dependent, wait-and-see approach. But the approach is no escape from today’s “unusual, new kind of uncertainty.” And it comes with perils of its own. By the time quarterly computation-based macroeconomic data such as gross domestic product indicate a downturn in economic activity, it will be too late to start preparing a new round of stimulus. Monthly, survey-based data such as the U.S. jobs report come with ambiguities that complicate their real-time interpretation. According to the latest data, 4 out of 5 laid-off U.S. workers perceive their layoff as temporary. Maybe their perception was right. A data-dependent approach is not wrong in principle. Like any other approach, however, it should come with a bias toward action, along with an acute awareness of the limits of even the best possible economic data.
The White House would be wise to use the respite of a brief wait-and-see period to, if anything, develop its own vision for what new stimulus legislation should contain. It need not be filled with what’s in the draft legislation from the U.S. House of Representatives, which includes tax breaks that would largely benefit high-income individuals and mentions “cannabis” 68 times. The time could be used, for instance, to develop mechanisms that address concerns about bailing out U.S. state governments with profligacy that predates the crisis. More broadly, the coming debate over new stimulus legislation offers Trump an opportunity to put forth a vision of a bailout for Main Street. His likely opponent in the upcoming 2020 presidential election cycle, former Vice President Joe Biden, negotiated bailouts for Wall Street firms and the automobile industry in 2009.
Uncertainty may fog the view U.S. officials have into the future state of the economy. But it does not necessarily block the view of the best course of action. In one direction lies the potential for catastrophic human and economic scars. In the other are downsides that have rarely ever been so muted, and a political opportunity the White House would be wise to seize.