The economy is likely to be crippled for months and fiscal rescue on a large scale, once again, is very much necessary.
As Joe Biden takes over the presidency amid a raging pandemic, he is proposing another large economic rescue package. The price tag of $1.9 trillion is high. But the need is great and the relief will address critical human and economic problems over the coming months.
At the beginning of 2021, the U.S. economy is stalling, if not regressing. In December of 2020, U.S. payroll employment was 9.8 million jobs below its February 2020 peak. Although there was a fast recovery in jobs over the past summer and early fall, November’s job gain did little more than keep up with trend growth in the labor force and in December we lost140,000 jobs. Rising initial unemployment claims in the first weeks of 2021 and slowing retail sales suggest the coming months’ data will be weak. These outcomes are not surprising considering record levels in Covid-19 infections, hospitalizations, and deaths. But they signal an economy in need of help.
The American Rescue Act (ARA) contains many pieces; this post focuses on the macroeconomic impact of four large components: public health funding, supplemental unemployment payments, assistance to state and local governments, and “stimulus” payments to the majority of American households. I then consider the effects of the plan on US national debt. I conclude that debt concerns should not prevent doing whatever it takes to defeat the virus as quickly as possible and mitigate the economic effects of the health crisis, effects that disproportionately affect the most vulnerable members of our society.
Public Health Funding
Detailed numbers for the proposed American Rescue Act are still forthcoming but it is clear that several hundred billion dollars will be targeted for broad public health measures. These will be dollars well spent. Indeed, effective funding in the next few months for aggressive public health measures may well save the government money over the medium term.
The economic crisis is the public health crisis. The economy cannot recover until new infections drop to levels that make it safe for 330 million Americans to return to something like a normal economic life. Our inability, both by government mandate and sensible personal choice, to travel, eat out, shop, and even receive necessary medical care has destroyed trillions of dollars of American incomes (a dollar not spent by one person is a dollar of income not earned by another). When incomes fall, tax revenues fall, and tax revenue losses from the Covid-19 crisis are now in the hundreds of billions of dollars.
Any activity the federal government can fund to reduce the time it takes to escape the pandemic, even if just by a few weeks, will have huge economic benefits and help restore private incomes and the associated tax revenues. We need to do whatever it takes to accelerate the production and distribution of vaccines, continue to track vaccine effectiveness and provide tests on a vast scale to track the progress of the virus and ultimately signal a return to safety in the general population. The benefit / cost ratio of these activities on purely economic grounds is certainly favorable. And the value of lives saved, suffering mitigated, and fear relieved will swamp even large economic gains.
Supplemental Unemployment Benefits
The Covid-19 economic crisis has decimated the labor market. As mentioned earlier, despite a surprisingly strong initial bounce back in jobs from the April 2020 disaster, employment losses at the end of 2020 are still huge. The 9.8 million job deficit between February and December of 2020 is greater than the worst months of the Great Recession crisis, widely recognized at the time to be the worst economic downturn since the 1930s Great Depression. (At the employment trough following the Great Recession in February 2010, payroll employment was “only” 8.7 million jobs below the January 2008 peak.) A rising share of these job losses are permanent. Any significant recovery seems months away, even given an optimistic assessment of the vaccine rollout.
Unemployment threatens the ability of households to pay for their most basic needs: rent and mortgage, utilities, food on the table, basic medical care. Regular unemployment programs are stingy in most states. Wage replacement of less than 50 percent, in some situations much less than 50 percent, is common.
The struggles of unemployment magnify inequality, especially in this crisis. Data from the widely cited Opportunity Insights Economic Tracker show low-wage employment (less than $27,000 per year) to be 21 percent below pre-pandemic levels in late October and predict further declines to near 25 percent in early 2021. High-wage employment (greater than $60,000 per year) has fully recovered. In joint research with Ella Needler, we study how job losses in the Covid-19 crisis compare across various demographic groups. We consider both the extent of job losses at a point in time and how long they persist by first measuring the difference between the group’s number of jobs in February 2020 and the group’s job number for each crisis month. Then, we add up these monthly job losses over all months of the crisis (as of this writing, March 2020 through December 2020), to compute a statistic we call “job-months lost.” Finally, we compare a demographic group’s share of aggregate job-months lost to that group’s share of total employment in February 2020. For white workers, their share of job-months lost in the Covid-19 crisis is 13% below their share of jobs in pre-pandemic employment. For Black workers, job-months lost are 28% higher than their pre-pandemic job share. The job-months lost share for Hispanic women is 60% above their employment share and the job-months lost share for workers without a high school diploma is double their share in pre-pandemic employment. While all recessions have unequal effects, inequalities are magnified in the Covid-19 crisis compared with the Great Recession. These outcomes correlate closely with inequality across occupations and income/education levels as workers in lower-paid service sectors are the ones most affected and they have the least opportunities to work remotely.
Federal supplements are vital to mitigate the unemployment crisis, especially in the lower half of the income distribution in which under-represented minorities constitute a disproportionate share. The supplements are far from perfect, especially since they need to be administered through outdated state systems that have cracked and broken under the burden imposed by the crisis. But these federal supplements seem to be the best rapid response to unemployment we have at this time and they need to continue.
While the human impact of unemployment is the main reason to provide better unemployment support, broad macroeconomic concerns are also important. If the unemployed cannot pay for their most basic needs, they certainly cannot engage in even minimal discretionary spending. Their reduced spending destroys other incomes and tax revenue spreading the crisis further into the economy. These “multiplier” effects compromise jobs even in sectors that do not need to contract to contain the virus. They weaken balance sheets and threaten debt payments, and will slow the pace of recovery even after virus-induced lockdowns can be rolled back.
It is tragic and embarrassing that the federal government dragged its feet on extending supplementary unemployment benefits after the CARES act payments expired in late July 2020. And all should take note that there was no remarkable surge of jobs following this expiration. As so often before, job growth monotonically declined in the fall, contradicting claims that a large share of the unemployed were refusing to work because they wanted to enjoy excessively generous unemployment payments.
In late December, political motivation from the Georgia Senate runoff elections along with the acceleration of Covid-19 infections led to the reinstatement of much needed federal unemployment supplements, albeit at half the level of the effective CARES act benefits. This was a step in the right direction, but not nearly enough. These benefits expire in mid-March 2021. With vaccine rollout already behind schedule and infections hitting records in January, there is no way the critical need for unemployment supplements will much recede by March. The Biden administration is correct to push for enhanced unemployment benefits into September 2021. One can only hope the need will be much reduced by that time.
State and Local Government
In recessions, government spending and employment should serve as a buffer relative to declining private activity. The federal government clearly plays this role, but state and local governments are often forced to cut spending and jobs when their tax revenues fall because, unlike the federal government, state and local borrowing ability is tightly constrained.
For this reason, the federal government can play an important role in bolstering state and local government finance during a recession. In the Covid-19 crisis, this kind of action is particularly important to expand critical public health services.
Some critics point out that state and local revenues have not fallen too much in this crisis, less than the $350 billion proposed in the ARA. But state and local tax revenues stalled in mid-2019 and little recovery is likely in early 2021. I estimate a shortfall relative to the previous trend of about $300 billion through the second quarter of 2021. Perhaps even more ominously, the trend growth of state and local revenue has been exceptionally low since the peak before the Great Recession. After growing well above 3% at an annual rate over every business cycle since the late 1970s, state and local revenues (adjusted for inflation) grew at an annual rate of just 1.4% at from the peak before the Great Recession until mid-2019. This growth rate is inadequate to support the growing demands for local government services. The last thing we need as we try to climb out of this crisis is for critical government services to be held back because federal rescue funding is inadequate.
Stimulus Checks
The CARES act provided significant payments to most American households ($1,200 for each adult and $600 for each child; higher-income households were excluded or received smaller payments). The Consolidated Appropriations Act providing an additional $600 to each individual (including children) was signed by President Trump on December 27, 2020. But the lame-duck President belatedly argued the checks should really be $2,000 per individual and most Democrats immediately jumped on board. As a result, Biden’s ARA proposes to “top up” the $600 benefit already passed with an additional $1,400 per person, taking the total to the politically driven $2,000.
The justification for this policy is less clear than the critical need for public health and unemployment initiatives. But it does have merit. Let us consider three ways in which the checks can help.
First, unemployment supplements do not address all the household financial stresses of the pandemic. One obvious problem is child care with the shutdown of in-person school attendance. If a parent, usually the mother, needs to quit her job or delay returning to work to take care of kids and supervise remote instruction, she will not qualify for unemployment but the family’s income will decline. (Labor force participation is down sharply in the crisis, with a somewhat larger drop for women than for men.) Individuals with co-morbidities that raise the risk of Covid-19 infection and severity may be forced to quit their jobs, and therefore are not eligible for unemployment benefits. Some workers who remain employed may lose hours and overtime due to the slow economy. (Although down sharply from a dramatic spring 2020 peak, the number of workers in December who report working part-time due to a slack economy remained more than 2 million above the February 2020 level.) Lower-income workers without sick leave may have to forego income as they recover, or, worse, go to work when they are contagious. Also, for many workers, even enhanced unemployment benefits leave them well short of their pre-crisis incomes. It is impossible to account specifically for these, and undoubtedly many other, sources of household financial stress in the crisis. Widespread and substantial financial relief from the stimulus checks will mitigate these problems.
Second, stimulus checks to households will increase demand to some extent. In most recessions, economic recovery requires more household spending. This recession is unusual, however, because we do not really want people to spend more if spending more means increasing activities that increase the risk of infection. For this reason, a larger proportion of the stimulus payments have been saved than would usually be the case. Nonetheless, stimulus payments will likely induce some additional spending, again more in the lower parts of the income distribution where the effects of the crisis are most acute.
The third benefit follows from the relative weakness of the second. If households spend just a small share of their stimulus payments, they are saving a large share. This behavior will strengthen household balance sheets by reducing debt and increasing liquid assets. Healthier balance sheets will support a more rapid expansion of demand when the health crisis passes, boosting the speed of recovery. Again, inequality plays an important role. For those at the top of the income distribution who have kept their salaries and benefitted from remarkable asset price increases, stimulus checks will have little impact. But the balance sheet effect that will reach an additional $5,000 or more is significant for lower- and middle-income families.
Critics of the stimulus checks point out that these temporary payments are less effective in encouraging spending than, for example, a permanent household tax cut. They are correct, and if a permanent tax cut of several thousand dollars for the bottom three-quarters of the income distribution were on the table, I would favor such a policy over one-off stimulus checks. But one more round of checks seems to be the feasible policy at this point. It is less critical than shoring up public health, backstopping state and local government finances, and enhancing unemployment, but it is still helpful.
What About the National Debt?
Federal debt held by the public has increased from 80% of GDP at the end of 2019 to nearly 100% at the end of 2020. The additional measures passed in December plus the ARA may push the ratio to the neighborhood of 110% by some point in 2021. Conventional thinking, often referred to as “common sense” in political debates, suggests such a rapid rise in debt is a big problem and the fear of excessive national debt likely poses the primary political barrier to undertaking the much-needed steps described above.
But what are the actual consequences of a large increase in our national debt at a time like this? The cost of additional debt is interest paid to bondholders, assuming, as has been the case for many decades, bonds that mature are rolled over into new securities. These interest costs should be adjusted for inflation since future dollars represent less “real” consumption or production as prices rise.
Ever since the beginning of the crisis, the inflation-adjusted interest rates on 5-year and 10-year US Treasury bonds, the best measure of the “real” interest rate on new government debt have been negative. As of this writing, the 10-year inflation-adjusted bond yield is about -0.9% while the 5-year inflation-adjusted yield is -1.6%. These negative rates are stunning. They imply the borrower, in this case the US federal government, will be financially better off than if they had not borrowed at all.
But, since the debt will almost certainly be rolled over, what happens if interest rates rise? There are many ways to answer this question, none of which imply that the interest cost of additional debt incurred to finance ARA spending is much of a barrier. I will describe three important responses here.
First, even if interest rates rise some, the increase is likely to be moderate. Real rates on longer-term Treasury bonds have spent the vast majority of the past 15 years below (positive) one percent. Rates on short-term securities have been even lower. The Federal Reserve is very clear that it intends to keep rates as low as they are now for an extended period, and even if the Fed begins to raise rates, rates are very unlikely to exceed levels of the past decade. Government debt is very, very cheap.
Second, while the fiscal response to the Covid-19 crisis has been enormous by historical standards, these measures are temporary. We cannot know how long it will take for the combination of vaccines and natural development of immunity to finally suppress this nasty disease, but it will recede eventually. When that happens, the federal deficit will decline quickly and economic growth will accelerate. The result will be a return of the national debt-GDP ratio to levels dictated by long-term fiscal policy. If there is some modest excess interest cost burden due to emergency fiscal policies during the crisis, it will shrink over time.
Third, we need to consider what will happen to debt and interest costs if we do not implement policies to address the economic fallout from the crisis. In this case, in addition to greatly increased human suffering, the pandemic will be longer and the economy will be weaker at the end of the health crisis. Households will be in worse shape and more businesses will fail. Tax revenues will be lower and the growth path of the economy will be weaker, both of which imply a higher debt-GDP ratio even if we do nothing.
Fortunately, some parts of mainstream economic thinking appear to have learned the lessons of the past few decades that fiscal stimulus from a government that controls its own currency can be enormously helpful in containing economic crises. The United States and many other countries suffered more than we had to in the Great Recession due to overblown fears about too much government borrowing. We should not repeat that mistake now.
How Many Rescue Bills and for How Long?
The ARA is the third major fiscal rescue package to address the economic fallout from Covid-19 in less than a year. Critics will complain with, “Are you kidding me? Another major spending blowout?” While fiscal rescue fatigue is understandable, the underlying problem derives from uncertainty about the pandemic. Again, the economic crisis is the public health crisis.
The CARES act of late March 2020 anticipated that the pandemic would be winding down by mid-summer of the same year (as shown by the August 1 expiration of unemployment supplements). Sadly, this was not the case, so the fiscal rescue needed to continue. Measures that should have passed in the late summer were delayed until December. Economic stress was higher than it needed to be. It would be a stretch too far to blame inadequate economic support in the second half of 2020 for the tragic resurgence of infection, illness, and death in the final months of the year. But the economic stress certainly was damaging, especially considering how it magnifies unacceptable inequalities.
Exciting news about the effectiveness of the Pfizer and Moderna vaccines gives reason for hope. But vaccine manufacture is not instantaneous and distribution is complex. Uncertainty remains about long-term effectiveness. As I write, new strains of the virus seem to increase the rate of transmission. The economy is likely to be crippled for months and fiscal rescue on a large scale, once again, is very much necessary. Considering all the uncertainties, it is good for the ARA to extend its most critical component, supplemental unemployment, into September 2021. And we cannot be sure that another rescue package will not be necessary. It all depends on how long the virus holds the world hostage.
In World War 2, US government spending and associated debt expanded at an unprecedented pace. These actions were necessary in that existential crisis, and they were followed by decades of strong economic performance. As US deaths from Covid-19 overtake the levels our country suffered in World War 2, our federal government is correctly called upon again to do whatever it takes, this time to defeat the virus and support the economy for all American citizens. The American Rescue Act proposed by President-elect Biden is an important and necessary step in this direction.
