In the United States, a race is on to vaccinate enough people before more contagious variants of coronavirus send infection rates skyrocketing again. The economy is struggling to recover from its sudden collapse last year. According to Federal Reserve Chair Jerome Powell, the real unemployment rate is close to 10 per cent, with low-wage workers, black people and Latinos suffering the most. A wave of layoffs by state and local governments hit by falling tax revenues is on the horizon.
President Biden and Democratic congressional leaders are rushing to pass a $1.9 trillion bill to combat the pandemic, provide emergency relief to those most affected, and prop up the economy. Yet this urgently needed rescue package is threatened by macroeconomic debates about whether this much stimulus is required. It is only to be expected that the minority Republicans are complaining that the proposed bill is too expensive, but centrist Democrats such as former Treasury secretary Larry Summers are chiming in as well, lecturing that too much assistance could “overheat” the economy and trigger rising inflation.
To summarise, the argument is as follows. Every economy has a level of “potential output” determined by its workforce and capital investments. If actual output is too low, it makes sense for the government to stimulate the economy by spending money to put people to work and produce more. But once potential output is reached, additional stimulus will result in too much money chasing a more or less fixed supply of goods, causing inflation. (Actual output can exceed potential output; the latter is defined as the level of activity that can be sustained without generating inflation, at least in theory.)
According to current (very hazy) estimates, the output gap—the difference between potential and actual output—is about $700bn per year, or around $60bn per month. In this context, a $1.9 trillion bill might look like too much stimulus. This is not the right way to look at it, however.
First, the output gap is a flow—money per month or year. A spending bill with fixed appropriations is a stock—one pile of money that will be spread across the next few years. Spending will inevitably stop, and in the interim, it is not a problem if actual output exceeds potential for a few quarters. (Indeed, the economy was running above potential for more than two years prior to the pandemic, and inflation stayed low.)
Second, what’s wrong with inflation? Various commentators have been predicting crippling inflation ever since the government’s response to the 2008 financial crisis. Although it has consistently failed to materialise, maybe this time is different. But inflation in and of itself is nothing to be afraid of. Annual inflation has remained around 2–3 per cent for most of the past 30 years, though below that for most of the past decade. There is no a priori reason to think that a higher inflation level—say, 4–5 per cent—would cause any major problems for the economy. It would have a distributive impact: current lenders (investors in the bond market) would lose, and current borrowers (homeowners paying mortgages, renters living in housing financed with debt, people with student loans) would win. But that all seems like a good thing, given current levels of inequality.
The problem, if there is one, is accelerating inflation: a situation in which people and companies, expecting inflation to rise in the future, demand higher prices for transactions in the future (such as wage contracts), causing the dreaded “wage-price spiral.” Since the 1970s, accelerating inflation has been the deepest fear of the macroeconomic community and the reason why Federal Reserve policy has fixated on controlling inflation rather than ensuring full employment. Since the mid-1990s (and explicitly since 2012), the Fed has targeted 2 per cent annual inflation; actual inflation has remained low in part because people assume that the Fed will act as necessary to keep inflation down. But there is nothing magic about the 2 per cent level. There’s no compelling reason why the economy couldn’t adapt to a modestly higher number, and it could even help central banks by making it easier for them to stimulate the economy by lowering interest rates in a recession.
More important, however, this whole debate over the appropriate amount of stimulus, which sees the economy as a single giant machine that can be controlled via a few levers, distracts from the crucial issues at hand.
For the past year, the United States as well as the wider world has faced the greatest emergency of most of our lifetimes. We know that people are being evicted from their homes, that small businesses are failing, that people’s job skills are eroding, that children are learning less than they would at school, that racial disparities are widening, that state and local budgets are in a shambles, and on and on.
At times like these, it is the duty of the federal government to act, and most people expect it to do so. We know what we need to do: invest in the vaccine rollout, extend assistance for those out of work, prevent a wave of evictions, keep small businesses afloat so Amazon does not become the entire economy, reopen schools, shore up low- and middle-income household balance sheets, replenish state budgets to prevent a wave of layoffs, and close racial economic disparities before they widen even further.
That is the task at hand. If it costs $1.9 trillion, that’s how much we should spend. We, especially those of us in the party that ostensibly represents workers and poor people, should not negotiate against ourselves by wringing our hands at the potential macroeconomic side effects of—God forbid—helping workers and poor people. This is not the time to spend less on schoolchildren, renters and state government employees in order to burnish our credentials as inflation fighters. This is the time to protect ordinary families—urban and rural, Black and White, Democratic and Republican—from economic devastation and show that the federal government can make a difference in their lives. $1.9 trillion is a small price to pay.
