When the pandemic first hit, it was expected that the world economy would be stuck in the mire of low-rate and low inflation for the foreseeable future, as in the case of Japan and Europe. Yet, America has been defying such pessimistic predictions with an unconventional pandemic recovery approach that features historic levels of fiscal spending and an inordinate tolerance for rising inflation rates in the short run. 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. 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 $1.9 trillion America Rescue Plan (ARPA) raises the stakes on overheating the economy.
Basic macroeconomics theory holds that the performance of the economy is contingent upon both supply and demand conditions. The supply side is concerned with the availability of labor, resources, and capital, as well as the technology to turn those inputs into marketable products. The demand side is linked to cash flow throughout the economy. In the short run, the greater the disposable income of each individual, the more they have to spend on goods and services, the greater the cash flow, resulting in a more prosperous economy.
When the pandemic hit, it shocked both the supply and demand sides of the economy. A combination of government-imposed lockdowns and deliberate precautions reduced the inputs, particularly labor, involved in the production of goods and services, resulting in supply shortages of critical consumer products such as medical supplies at the onset of the crisis. On the demand side, bearish sentiments and a lack of liquidity in financial markets in the spring of 2020 spread fear and curtailed consumer spending, depressing the demand for goods and services.
In response to these developments, America’s central bank and the Federal government adopted a Keynesian doctrine of economic recovery, implementing expansionary fiscal and monetary policies in the form of relief packages, tax cuts, increased public spending, quantitative easing, and etc. Unusually generous COVID relief packages rolled out under the CARES act and the 900$ billion stimulus 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 May 2020, a month after the CARES act was passed, and have remained significantly higher than pre-pandemic levels ever since. 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. 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. What does this all mean? Demand side issues are no longer plaguing the American economy. In fact, January 2021 data shows that America’s retail sales were 7.4% higher than a year earlier.
Therefore, the issue is not a lack of purchasing power, or demand, but the fact that individuals are not spending enough of the money given to them that is meant to jumpstart the economy. This is due to the virus’ persisting disruption to aggregate supply, as many business restrictions remain in place and the reopening progress is hindered by the pace of vaccination programs. 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. 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. 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. Instead, the bill focuses on giving single-filing taxpayers with an income of $75,000 or below, heads of household with an income of $112,500 or below, and married couples filing jointly with an income of $150,000 or below an additional $1400 in direct payments, compounding the huge pile-up of disposable income for which consumers are more likely to hoard than spend until the economy fully reopens.
More controversially, the American Rescue Plan Act pledges to increase Federal funding for school reopening and bailouts of local governments. The plan will send $170 billion to schools and universities to help them take steps to reopen, such as purchasing masks and sanitation supplies, creating smaller classes, and upgrading ventilation systems. ARPA will also provide $350 billion for local governments, many of which are feeling the squeeze of rising expenses and decreasing revenue due to the economic downturn. 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. These criticisms are not entirely unwarranted. For one, conservatives are wary of expanding the Federal government’s involvement in the public education system – which has been governed by state and local authorities in the past – and they are critical of the funding of this provision, which according to conservatives won’t even be available to schools until next year. For another, Republicans are hesitant to provide more cash to local governments, calling the move a cash handout to high-tax lieral enclaves, democratic states. They based their refutation on research that shows the budget situation in many states is better than expected, such as California where there exists a surprising budget surplus.
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. If President Biden’s gamble pays off, it is likely that America will avoid the low inflation low rate trap in which other countries have been caught, and massive fiscal spending and loose monetary policy may become the new norm of recession responses. If the gamble fails to pay dividends, however, risking to overheat the economy will come at a severe cost. The passing of ARPA brings America ever closer to the economic nightmare of rising debts, inflationary issues, and the loss of credibility of its central bank. President Biden has already taken the U.S. government’s pandemic-related spending to a sum of nearly $3 trillion (14% of America’s pre-COVID GDP) since last December and $6 trillion total has been paid out since the onset of the crisis, aggravating the already mind-boggling national debt. Additionally, under the Federal Reserve’s new “average inflation targeting regime,” short-term inflation will rise over its 2% long-run target in order to make up for past deficits. Heightened inflationary expectations have already had a ripple effect in markets across the globe: ten-year U.S. Treasury bond yields, which are inversely proportional to prices, have doubled since last spring; the Australian central bank had to increase its bond purchases to maintain stable yield rates, and the European Central Bank has been deliberating a similar policy. If policymakers were too timid in the aftermath of the Great Recession in 2008, as many have suggested, the current situation calls for prudence.