Joe Biden signed the pandemic relief legislation just after 2pm on Thursday, March 11, in the Oval Office, a day earlier than previously announced © AFP via Getty Images (link)
To avoid the low-rate and low-inflation trap that Japan and the EU have been caught in, America has adopted an unconventional pandemic recovery approach that features historic levels of fiscal spending and an inordinate tolerance for rising short-term inflation (Source #2). With the signing of the American Rescue Plan Act (ARPA) on March 11, President Biden furthered America’s bold interventionist policies. Like previous stimulus packages, the new bill promises direct payments to many Americans, an extension of jobless aids, the disbursement of funds for vaccine distribution efforts among other initiatives (Source #6). However, in the wake of the $2.2 trillion CARES Act of 2020 and the $2.3 trillion Consolidated Appropriations Act of 2021, Biden’s $1.9 trillion America Rescue Plan (ARPA) raises the stakes of overheating the economy.
Basic macroeconomics theory holds that the performance of the economy is contingent upon both supply and demand conditions. The supply side is concerned with the availability of labor, resources, and capital, as well as the technology to turn those inputs into marketable products, while the demand side is linked to cash flow throughout the economy (Source #4). In the short run, the greater the disposable income of each individual, the more they have to spend on goods and services, the greater the cash flow, resulting in a more prosperous economy.
When the pandemic hit, it shocked both the supply and demand sides of the economy. A combination of government-imposed lockdowns and deliberate precautions reduced the inputs, particularly labor, involved in the production of goods and services, resulting in supply shortages of critical consumer products such as medical supplies at the onset of the crisis (Source #4). On the demand side, bearish sentiments and a lack of liquidity in financial markets in the spring of 2020 spread fear and curtailed consumer spending, depressing the demand for goods and services (Source #4).
In response to these developments, America’s central bank and the Federal government adopted a Keynesian doctrine of economic recovery, implementing expansionary fiscal and monetary policies in the form of relief packages, tax cuts, increased public spending, quantitative easing, etc. Unusually generous COVID relief packages rolled out under the CARES act and the 900$ billion stimuli included in the Consolidated Appropriations Act of 2021 put ample cash into the hands of consumers. According to data from the Bureau of Economic Analysis, private savings rates surged to a historic high of 33.7% in April 2020, a month after the CARES act was passed, and have remained significantly higher than pre-pandemic levels ever since (Source #7). A recent study by the JPMorgan Chase Institute shows that the poorest Americans’ bank balances were some 40% higher than the year before and liquid assets rose in value by 11% in the past year (Source #3). This is not surprising considering top-ups to unemployment benefits in America have ensured that some 40% of unemployed Americans, especially low-income earners in industries such as retail, accommodation, and food services, earned more from the state in the form of subsidies and direct payments than when they worked (Source #3). What does this all mean? Demand-side issues are no longer plaguing the American economy.
So, what’s to blame? The virus’ persisting disruptions to aggregate supply have prolonged business restrictions, and the progress of reopening has been hindered by the pace of vaccination programs (Source #4). Stuck at home to a greater or lesser degree and unable to spend as much money as they normally would in restaurants, bars, and cinemas, American consumers have already accumulated $1.6 trillion in excess savings over the past year (Source #2). The bottom line is, America does not need another mammoth relief bill financed by debt that puts more cash into the hands of American consumers at the risk of overheating the economy. What America needs is a plan that ramps up efforts to eliminate the hurdles that currently preclude the full reopening of the economy, namely supply-side restrictions caused by the pandemic.
To resolve supply-side issues, one would expect President Biden’s plan to focus on expediting the return to normalcy by scaling up vaccine production and distribution (Source #4). Yet, the $16 billion devoted to vaccine distribution and $50 billion devoted to virus testing and contact tracing pale in comparison to the Bill’s 1.9 trillion total (Source #4). Instead, about $1 trillion will be devoted to $1,400 per-person direct payment checks and other forms of fiscal relief, potentially compounding the huge pile-up of disposable income for which consumers are more likely to hoard than spend until the economy fully reopens (Source #1).
More controversially, the American Rescue Plan Act pledges to increase Federal funding for local governments. Specifically, ARPA will provide $360 billion for state and local governments to sustain “vital services” during the pandemic (Source #1). Republicans, however, have fought hard against these provisions, disparaging the plan as a political agenda passed under the pretense of jumpstarting the economy to reward the left’s political clients (Source #4). Their wariness to provide more cash to local governments is not entirely unfounded. Research shows that the budget situation in many states is better than expected, such as in California where there exists a surprising budget surplus (Source #5).
Whether the American Rescue Plan Act is indeed warranted by legitimate needs in the overall economy, its passage increases the risk of letting inflation run wild. As a recent Economist article diagnosed: if President Biden’s gambit fails to pay dividends, ARPA will bring America ever closer to the economic nightmare of rising debts, inflationary issues, and the loss of credibility of its central bank. If policymakers were too timid in the aftermath of the Great Recession in 2008, as many have suggested, the current situation calls for prudence.
1. “The American Rescue Plan,” The White House (March, 2021)
2. “Joe Biden’s Stimulus is a High-stakes Gamble for America and the World,” The Economist, (March 13, 2021)
3. “The World’s Consumers are Sitting on Piles of Cash. Will They Spend it?,” The Economist, (March 9, 2021)
4. “America Doesn’t Need More Stimulus,” The Wall Street Journal, (March 14, 2021)
5. “Biden’s Covid stimulus plan: It costs $1.9tn but what’s in it?”, BBC, (March 6, 2021) https://www.bbc.com/news/business-56019033
6. “Covid stimulus: Biden signs $1.9tn relief bill into law,” BBC, (March 11, 2021)
7. “Personal Saving Rate,” Federal Reserve Economic Database, (April 20, 2021)