Op-ed: Stimulus Policies Should Better Consider Our Fiscal Future

A shorter version of the below was originally published by Morning Consult here.

President Joe Biden’s inbound COVID relief proposal was released last week, touting an additional $1.9 trillion in semi-targeted economic support. If Congress passes the plan as-is, it will combine with December’s $900 billion aid package for a total additional emergency response equal to 13% of GDP, more than 25% including all of last year’s emergency allocations.

While both parties tend to agree, along with a majority of Americans, that Congress has to continue to borrow and spend right now to keep us afloat, few have given the consideration to our future fiscal policy direction that we all deserve.

Biden’s new plan puts a lot up for debate, as any grand plan from a new president will. Certainly, there is a need for continued support for the unemployed (unemployment remains highly elevated with a growing concern of long-term scarring), those in tenuous housing situations, families struggling to afford food (see Food Sufficiency and Food Security tables at the Census) — and of course we should do anything in our power to help the health care system eradicate COVID, while opening schools and businesses before the onset of unrecoverable permanent effects. However, similarly sized economic relief checks (a.k.a., stimulus checks, which have been tried at least five times by past administrations with little favorable impact to the economy), unemployment benefit extensions and state and local relief had substantially lower-than-expected returns in 2020 (in past attempts, as is likely in 2020, states cut their own funds in favor of spending the "free" money from D.C., with little net effect). For example, a recent study by the NBER/University of Chicago found that only 15% of the recipients of direct stimulus money from the CARES Act actually spent it.

The girth of the proposed unemployment benefit expansion and minimum wage adjustments within the Biden proposal may also have unexpectedly adverse effects. Both have honorable objectives, but too much in unemployment can shrink the labor pool when employers are clamoring for workers, while some contend that outsized minimum wages will reduce the incentive to draw from whatever labor pool does exist. Legislators should be wary of the diminishing returns to increases in these investments.

With cheap borrowing rates and a high downside risk to not getting it right, one can understand the temptation to go big. Janet Yellen argued as much before the Senate Finance Committee this week, but Congress’ job is to pare ambition and consider recent data to choose the best policy path, further placing weight on the future fiscal policy implications of today’s relief packages.

Having already surpassed the size of the economy in 2020 for the first time since World War II, when we had a record deficit of 4.2% of GDP (2020's deficit crossed 16%), our national debt is only expected to increase in the near term, exacerbating the risk of over-extending our financial resources.  Rising debts correlate with slowing economic performance and reduced individual income potential as we spend more on interest and less on good investments.  The cost to service our debt alone, for example, is expected to pass the amount we spend on national defense in a couple of decades, likely sooner if rates shift (and they will).

Counterarguments suggest that risks are mitigated if we simply lend to ourselves, historic drops in interest rates will continue to reduce borrowing costs and the economy will grow fast enough to cover any additional debt burden (see expanded discussion by Furman and Summers here, which captures these arguments well). But are we confident enough in our estimates to wager the next generation? It is almost impossible to predict shifting sentiment and building interest rate risks, which often change rapidly and are amplified by larger debt loads.  Further, while we can make our best guesses, we can’t predict whether future shocks will lead to insurmountable hiccups in our outlook on growth (e.g., 2020).

A responsible addition to this year’s COVID counterattack will include policies that temper our debt trajectory, remove the need for legislative intervention in the next crisis and provide parameters to eventually reduce the deficit. We have a number of automatic stabilizers in place that can use a bit of revision — for example, allowing for larger swings of fiscal support when necessary, cutting back faster when the good times return.

If there is anything that the Great Recession and the Great COVID Lockdown have proven, it is that legislators can’t act fast or firmly enough, will always get it wrong to some extent and will necessarily pass unrelated extras while we are distracted. It is an imperfect art that we hope will end in our favor, but pre-emptive planning can prevent waste and ensure the timeliness of implementation.

When COVID is finally eradicated, or we learn to live with it, we need to ensure a methodical, unbiased and politically apathetic approach to slowing the spigot. There are many solid proposals that will slow deficits without crimping growth, without requiring harsh austerity measures.

A controlled, long-term approach that ensures harmless deficit reductions can have a lasting and positive effect on our economic future. In fact, my own research covering time periods over the last four decades found that deficit reductions can improve economic performance almost immediately – if done properly – with benefits lasting well into the future. The "if done properly" part is what gets most proposals in trouble. My study - which supported evidence presented by others (e.g., see Alesina, Favero, and Giavazzi) -suggests that we can cut deficits by reducing the spending portion of our federal outlays to have a positive short-term effect, especially if those cuts are substantially larger than the portion allotted to tax adjustments. Stanford's John Taylor recently proposed a mild cut of .1% of GDP per year, to ensure a gradual path towards fiscal sustainability, hardly the "harsh austerity" touted by opponents of any type of fiscal policy cuts (though, his proposal was pre-COVID and may require a small, upward revision).

It’s difficult to conduct a thoughtful and well-planned policy approach when faced with an unexpected and unprecedented crisis, which is why better long-term fiscal policy plans should have been enacted during our recent growth spurts. Fortunately, we are not in over our heads yet. There is still time for a beneficial approach to long-term fiscal sustainability, and it should be included in today’s policies.

Justin Vélez-Hagan, Ph.D., is the principal advisor of Macro Policy Advisors and author of the books The Paradox of Fiscal Austerity (Lexington Books) and The Common Sense behind Basic Economics.