Fiscal Stimulus Will Help Set Up Economy for Rebound

posted by Michael Lewis on March 19, 2020 - 12:00am

The federal government has approved two “phases” of fiscal relief for the current COVID-19 crisis, an $8B bill supporting medical work and expanding testing for the virus signed on March 6, and a $100B expansion of sick and family medical leave that President Trump is signing today. The vastly larger Phase 3 package will likely come up for a vote within the next several days. Collectively, this fiscal stimulus will cost more than a trillion dollars, putting it on par with the combined Obama and Bush administrations’ responses to the Great Recession.
So far, however, the 2020 stimulus package is better targeted to the actual economic damage than those 2008-09 measures, and the relief will be much more front-loaded. More federal money is going directly to individuals, and there are fewer strings attached to relief for businesses. Lawmakers have not larded the package with pet construction projects and other programs with only a tangential connection, if that, to the current crisis. Or we should say that they have not done it yet.
Having passed three fiscal packages in less than three weeks, Congress and the White House may do even more down the line.
Unless Phase 3 changes considerably before passage, FMI expects that this fiscal stimulus will be far more effective than the 2008-09 effort, and that it will provide some help setting the stage for a solid rebound beginning in 2020-H2.
The caveat is that “more effective” is not the same as “very effective.” The macro problem, at this moment, is not inadequate consumer demand; it is that consumers will not and, in many cases, cannot fulfill that demand while much of the country is closed or “social distancing.” More precisely, they cannot spend as much as they usually would. Businesses face the same obstacles.
Fiscal stimulus cannot undo the effects of the outbreak; indeed, much of this money will be “wasted” -- going straight into the bank instead of consumption and investment. Nonetheless, the package will ameliorate some economic pain.
Millions of people are being laid off or having their hours at work curtailed. Most will be in the lower-wage rungs, and few of those people have sufficient savings. A federal check to this group will be spent quickly.
However, the vast majority of Americans are still getting their regular paychecks and so do not “need” federal help. Most will hold nearly all of it in reserve until the crisis lifts; even then, most of the windfall will likely stay in savings. Some people will give a portion to charity.
The business bailouts will just keep firms above water until the crisis lifts. Output will not increase markedly, but layoffs should be contained. Labor markets are still very tight, and firms are very reluctant to let workers go, even temporarily, for fear that they will not come back.
The package will be funded entirely by borrowing; this prospect has already pushed up bond yields up from their cellar. Given still-very-low long rates, this is manageable now. But higher federal debt and eventual higher interest payments will be a drag on future growth. There ain’t no such thing as a free lunch, to coin a phrase.
Aside from the differences in structure, which are considerable, this current stimulus has two key advantages over the Great Recession tactics.
First, this stimulus package is coming in the still-early days of the crisis. More than half the funds, $500B+, will be disbursed by the end of 20Q2 (if Congress backs the White House timetable). In contrast, Obama’s stimulus was approved in February 2019, 15 months after the Great Recession began and just four months before it ended. Only a fraction of the total was spent before the expansion began that June, and much of the spending did not happen for two years.
We do allow that simply passing that bill might have inspired some hope in the economy, but light at the end of the tunnel was already in sight. Bush’s stimulus effort was approved in early 2008 but was much smaller at $300B.
Second, this economic downturn is entirely exogenous; in key respects, it is much simpler than the Great Recession. Disbursing money, if done with a modicum of vision and care, can counter some of the drag from the coronavirus. In 2007-09, there were endemic problems with the credit markets than dwarfed anything that we have seen in recent day. Back then, they required substantial support and, in some cases, reform.
In terms of structure, this stimulus package is front-loaded: Payments to individuals, half the total, would go out in the next two months. Most of the industry-specific and general small business assistance will be tapped this year.
In contrast, the Obama stimulus package was much slower. There was more than $400B in payments to individuals, but these came as lower withholding -- a few dollars in each paycheck -- and weekly unemployment benefits. They lacked the immediate impact of a big check or two.
The hundreds of billions of dollars of program spending moved at a glacial pace. With Democratic control over both houses of Congress, Obama did not want to “let a crisis go to waste.” Thus, the door was thrown open for all manner of pork projects, few of which could be undertaken in a timely fashion.
Obama also forced some industrial restructuring, notably on the automotive industry, that favored unions over fixing problems.
Phase 1, approved on March 6, was $8B, mostly directed to medical research and testing for the virus. Phase 2, which President Trump will sign today, provides two weeks of paid sick leave for many of those who are infected and paid family leave for parents of children whose schools have closed, as well as more funding for Medicaid, SNAP/Food Stamps and free COVID-19 testing. This will total about $100B.
Phase 3 will likely run close to $1 trillion. As promoted by Treasury Secretary Mnuchin, this would include $500B in direct payments to individuals this spring, $200B in support to airlines, tourism and other virus-damaged industries, and a $300B loan facility for small businesses that are “disrupted” by the outbreak.
The payments to individuals would replace the payroll tax cut advocated earlier by President Trump. Some GOP senators did not want to touch anything that could be connected to Social Security, while others argued (correctly) that those laid off due to the virus are not getting paid and hence would not benefit from a payroll tax cut. The new White House plan would send $500B to individuals in two installments this April and May. The amount received would depend on pre-virus income and family size; some households would receive up to $2,000. Very high-income households would presumably get little or nothing.
The Senate Republican caucus is mostly on board with the size of the total rescue package. Some Senators want to focus on those who have been idled by the virus rather than others who do not “need” the money. Nonetheless, tactical considerations -- how long it would take to identify and pay only those people out of work or working much less due to the virus -- plus the political benefits of a general tax cut in an election year will likely carry the day.
The few remaining Republican deficit hawks will object, but there are more than enough votes on the other side of the aisle to pass this bill.
Following the dictum of former Obama Chief of Staff and Chicago mayor Rahm Emmanuel, some Democrats are determined not to “let a crisis go to waste.” Elizabeth Warren, for example, wants any bail-out/industry support to include requirements to give workers a seat on the boards of directors of any beneficiary company. As they did in 2009, Democrats may also try to limit the CEO pay in such companies.
For the most part, though, Democrats are just demanding a bigger package, e.g., payments of $4,500 to families. They also want to require all companies to provide paid sick leave and family leave benefits even after this crisis is resolved.
Trump and Mitch McConnell, we believe, will be able to brush aside those concerns for this bill. The new plan should pass in close to the proposal form, likely by early next week.
Later on, Democrats and some Republicans will surely put up a “Christmas Tree” of assorted self-styled recovery projects in their districts. Such pork always follows emergencies, and we doubt Trump (or a Democratic successor) will resist them. Should Democrats win the presidency this fall, they will no doubt succeed in setting new near-universal requirements for paid sick and family leave.