By Jorge Barro, Ph.D.
Fellow in Public Finance, Center for Public Finance
President Biden’s $1.9 trillion relief package, called the American Rescue Plan, is on track to be signed into law this week. Does the measure do enough to address the short- and long-term economic impacts of the crisis? Public finance fellow Jorge Barro answers five critical questions about the plan.
Is this the right amount of money to help Americans get through the pandemic?
The goal of the stimulus package should be to dampen the pandemic’s impact on households, businesses, institutions and the economy at large. Without this stimulus package, the Congressional Budget Office has projected a return of the economy to its pre-pandemic peak by mid-2021. That leaves the question of how much of the measure targets specific needs. The bill dedicates $422 billion to means-tested stimulus payments, which are not tied to any specific losses corresponding to the pandemic. About $350 billion goes to state and local governments, which have fared far better than expected. A large share of the remaining outlays finance expenditures unrelated to the pandemic. A well-targeted bill should not exceed $1 trillion, and a very reasonable package would be well below that amount.
Why is there concern over the $1.9 trillion price tag?
The primary reason that some economists and others disapprove of the package is its magnitude. When economists talk about getting the economy “back on track,” they usually mean getting gross domestic product — a measure of total economic output — back to its potential. The difference between current and potential output is known as the “output gap,” and former International Monetary Fund chief economist and MIT professor Olivier Blanchard (who supports some stimulus) gives a rough high-end estimate of its value at $900 billion. As a result, the stimulus package risks pushing output above its potential and “overheating” the economy — a euphemism for inflation. There are broader concerns over the lack of target in the bill and the partisan nature of its passage, but regarding the macroeconomic impact, the biggest concern is the inflationary consequences resulting from the bill’s size.
Does the package do enough to offset the worst long-term effects of the pandemic?
Economists think separately about short-term and long-term macroeconomic trends. While the bill could expedite the short-term recovery, it does little to address the long-term macroeconomic impact of the pandemic. Nearly every determinant of long-term economic growth, including educational attainment, immigration and the fiscal outlook, have taken a serious hit during the pandemic. The bill does allocate a small share of the funding to education, which could help offset some of the disparate setbacks caused by remote instruction. However, unless we begin seriously addressing all three issues, the United States’ long-term macroeconomic outlook could deteriorate.
What are some pros and cons of the measure?
Several elements of the bill make sense, including health care expenditures that directly combat the pandemic and targeted fiscal aid to households. Most would agree that the best way to get the economy back on track is to end the pandemic. In that respect, funding to improve vaccination or to mitigate the risks of infection seem well-spent. Unemployment benefit extensions also make sense, but this requires proper implementation. To balance the insurance value with the adverse incentives of the benefit, the magnitude of the benefit should be scaled down throughout the duration of the unemployment spell. Instead, the bill enhances unemployment benefits, which could lead to a prolonged labor market recovery, similar to the aftermath of the financial crisis. A better bill would also reduce payments to state and local governments, eliminate untargeted spending and focus on long-term issues.
How should we pay for the stimulus package?
It would be ideal to pay for the stimulus package through fiscal austerity after the economy has recovered, but we may actually pay for it sooner than expected. A large share of the new debt has been purchased by the Federal Reserve. In doing so, the Federal Reserve increased the supply of money, which has already begun to generate a marked resurgence in projected inflation. In that sense, inflation operates like a tax on cash holdings. The residual increase in debt that’s not financed by inflation will need to be financed by future expenditure reductions or tax increases.