I wrote earlier this week about the Federal Reserve’s limited scope to help fight the economic drag from the coronavirus epidemic. The Fed is willing to help stimulate the economy — and has already cut interest rates by half a point — but monetary policy only matters so much in a situation where factories are shut down, supply chains are disrupted, and consumers aren’t spending on travel and restaurants because they’re trying to avoid exposure to a virus.
What about fiscal policy? Some economists, especially on the left, have started calling for a fiscal stimulus program (that is, some combination of more spending and less taxation) to boost the economy in the face of coronavirus. President Trump has urged Democrats in Congress to propose a temporary payroll tax cut, which would be a form of fiscal stimulus. But fiscal policy faces similar limitations to monetary policy: It can boost aggregate demand by making people feel wealthier, but only if the reason they weren’t spending in the first place was insufficient wealth.
Doug Holtz-Eakin, the president of the conservative American Action Forum and a former top economic adviser to George W. Bush and John McCain, told me he does not think a fiscal stimulus package is warranted at this time. He says the most important policies to prevent economic damage from an epidemic are the policies that fight the epidemic directly. That includes public spending measures such as the approximately $8 billion spending package that congressional leaders agreed upon on Wednesday. It also includes efforts to shape public reaction to the epidemic, ensuring that the public takes appropriate action to reduce the spread of disease without becoming unreasonably fearful.
As for the merits of fiscal stimulus, Holtz-Eakin noted that supply shocks — such as disruptions to supply chains — can’t be fixed through fiscal stimulus. A demand shock due to social-distancing measures during an epidemic (like people forgoing cruises and staying away from the mall) is likely to be appropriate and unlikely to be changed through economic policy. And as for the concerns that a demand shock could persist after the epidemic is over? Holtz-Eakin said demand tends to recover robustly after disasters, as people go out and buy the backlog of things they didn’t buy while they were disconnected from the economy.
“You get a V[-shaped recovery] because people now do the spending they didn’t do the last quarter,” he said. “So what is the fiscal-policy problem you are trying to solve?”
His last point is similar to one that China expert Patrick Chovanec made to me a month ago: When disasters disrupt supply chains briefly, the total loss of economic activity tends to be small because factories that were closed reopen and run overtime to catch up on their orders. But a key word in that sentence is “briefly.” The longer the disruption persists, the more likely that business is lost permanently, and the more likely there will be an economic hangover that takes time to recover from after the disaster is over. That hangover takes the form not just of lower business profits but lower earnings and lower spending by consumers.
That’s a reason Jason Furman, who served as chairman of President Obama’s Council of Economic Advisers, told me he would recommend a stimulus package of around $300 billion, to be disbursed over approximately 12 months. He would provide some form of broad-based cash benefits to individuals, such as a payroll tax cut or additional tax rebate checks. He would also provide increases in safety-net benefits such as unemployment insurance — subject to a trigger that would expand them only if the unemployment rate actually rose significantly. He would similarly provide aid to states to pay for increased Medicaid costs, subject to an economic trigger that would provide the money only if needed.
Furman acknowledges that both the size of a needed stimulus package and the right time to extend it are uncertain in the context of an epidemic. But with government borrowing costs so low — the ten-year treasury bond yield has now fallen below one percent — he contends the cost of stimulating too much is low, while the cost of stimulating too little would be substantial. He’s also not sure how important it is to get the timing right. If you send out rebate checks too early, and people receive them while they’re staying home and spending less money for public health reasons, that will still leave them in a stronger financial position once the epidemic has abated, which should boost their spending and speed the economic recovery.
That said, Furman noted significant political obstacles that stand in the way of a stimulus package. It is possible for a divided government to come to agreement on a fiscal stimulus package in the face of a deteriorating economy in an election year — George W. Bush and Nancy Pelosi did it in 2008 — but Trump’s relations with Democrats in Congress are significantly more fraught than Bush’s. And while a stimulus package would boost the economy, it is not so absolutely necessary that it can overcome political difficulty in the way that, say, the Troubled Asset Relief Program did several months after the 2008 stimulus act, as the economy looked poised to enter a depression.
“The question is, the two sides, is their goal to make sure it happens, like TARP,” Furman said. “Or is it a nice to have but if it doesn’t happen that’s okay too, in which case they’re positioning to blame the other side for failure? This is definitely not TARP. I think this is a nice to have.”