Discretionary fiscal policy writ large: Biden’s stimulus plans

On 10 March, the House of Representatives gave final approval to President Biden’s $1.9tr fiscal stimulus plan (the American Rescue Plan). Worth over 9% of GDP, this represents the third stage of an unparalleled boost to the US economy. In March 2020, President Trump secured congressional agreement for a $2.2tr package (the CARES Act). Then in December 2020, a bipartisan COVID relief bill, worth $902bn, was passed by Congress.

By comparison, the Obama package in 2009 in response to the impending recession following the financial crisis was $831bn (5.7% of GDP).

The American Rescue Plan

The Biden stimulus programme consists of a range of measures, the majority of which provide monetary support to individuals. These include a payment of $1400 per person for single people earning less than $75 000 and couples less than $150 000. These come on top of payments of $1200 in March 2020 and $600 in late December. In addition, the top-up to unemployment benefits of $300 per week agreed in December will now continue until September. Also, annual child tax credit will rise from $2000 annually to as much as $3600 and this benefit will be available in advance.

Other measures include $350bn in grants for local governments depending on their levels of unemployment and other needs; $50bn to improve COVID testing centres and $20bn to develop a national vaccination campaign; $170bn to schools and universities to help them reopen after lockdown; and grants to small businesses and specific grants to hard-hit sectors, such as hospitality, airlines, airports and rail companies.

Despite supporting the two earlier packages, no Republican representative or senator backed this latest package, arguing that it was not sufficiently focused. As a result, reaction to the package has been very much along partisan lines. Nevertheless, it is supported by some 90% of Democrat voters and 50% of Republican voters.

Is the stimulus the right amount?

Although the latest package is worth $1.9tr, aggregate demand will not expand by this amount, which will limit the size of the multiplier effect. The reason is that the benefits multiplier is less than the government expenditure multiplier as some of the extra money people receive will be saved or used to reduce debts.

With $3tr representing some 9% of GDP, this should easily fill the estimated negative output gap of between 2% and 3%, especially when multiplier effects are included. Also, with savings having increased during the recession to put them some 7% above normal, the additional amount saved may be quite small, and wealthier Americans may begin to reduce their savings and spend a larger proportion of their income.

So the problem might be one of excessive stimulus, which in normal times could result in crowding out by driving up interest rates and dampening investment. However, the Fed is still engaged in a programme of quantitative easing. Between mid-March 2020 and the end of March 2021, the Fed’s portfolio of securities held outright grew from $3.9tr to $7.2tr. What is more, many economists predict that inflation is unlikely to rise other than very slightly. If this is so, it should allow the package to be financed easily. Debt should not rise to unsustainable levels.

Other economists argue, however, that inflationary expectations are rising, reflected in bond yields, and this could drive actual inflation and force the Fed into the awkward dilemma of either raising interest rates, which could have a significant dampening effect, or further increasing money supply, potentially leading to greater inflationary problems in the future.

A lot will depend what happens to potential GDP. Will it rise over the medium term so that additional spending can be accommodated? If the rise in spending encourages an increase in investment, this should increase potential GDP. This will depend on business confidence, which may be boosted by the package or may be dampened by worries about inflation.

Additional packages to come

Potential GDP should also be boosted by two further packages that Biden plans to put to Congress.

The first is a $2.2tr infrastructure investment plan, known as the American Jobs Plan. This is a 10-year plan to invest public money in transport infrastructure (such as rebuilding 20 000 miles of road and repairing bridges), public transport, electric vehicles, green housing, schools, water supply, green power generation, modernising the power grid, broadband, R&D in fields such as AI, social care, job training and manufacturing. This will be largely funded through tax increases, such as gradually raising corporation tax from 21% to 28% (it had been cut from 35% to 21% by President Trump) and taxing global profits of US multinationals. However, the spending will generally precede the increased revenues and thus will raise aggregate demand in the initial years. Only after 15 years are revenues expected to exceed costs.

The second is a yet-to-be announced plan to increase spending on childcare, healthcare and education. This should be worth at least $1tr. This will probably be funded by tax increases on income, capital gains and property, aimed largely at wealthy individuals. Again, it is hoped that this will boost potential GDP, in this case by increasing labour productivity.

With earlier packages, the total increase in public spending will be over $8tr. This is discretionary fiscal policy writ large.

Articles

• Biden’s $1.9 trillion COVID-19 bill wins final approval in House

Reuters, Susan Cornwell and Makini Brice (10/3/21)

• Biden’s Covid stimulus plan: It costs $1.9tn but what’s in it?

BBC News, Natalie Sherman (6/3/21)

• Biden’s $1.9 Trillion Challenge: End the Coronavirus Crisis Faster

New York Times, Jim Tankersley and Sheryl Gay Stolberg (22/3/21)

• Joe Biden writes a cheque for America – and the rest of the world

The Observer, Phillip Inman (13/3/21)

• Spend or save: Will Biden’s stimulus cheques boost the economy?

Aljazeera, Cinnamon Janzer (9/3/21)

• After Biden stimulus, US economic growth could rival China’s for the first time in decades

CNN, Matt Egan (12/3/21)

• Larry Summers, who called out inflation fears with Biden’s $1.9 trillion COVID-19 relief package, says the US is seeing ‘least responsible’ macroeconomic policy in 40 years

Business Insider, John L. Dorman (21/3/21)

• With $1.9 Trillion in New Spending, America Is Headed for Financial Fragility

Barron’s, Leslie Lipschitz and Josh Felman (30/3/21)

• Biden unveils ‘once-in-a generation’ $2tn infrastructure investment plan

The Guardian, Lauren Gambino (31/3/21)

• Biden unveils $2tn infrastructure plan and big corporate tax rise

Financial Times, James Politi (31/3/21)

• The Observer view on Joe Biden’s audacious spending plans

The Observer, editorial (11/4/21)

Videos

• What’s in the $1.9 trillion Covid bill Biden just signed? You might be surprised

NBC News, Sahil Kapur and Benjy Sarlin (11/3/21)

• Economist: Biden’s $1.9 trillion stimulus plan is not too large

CNN, Paul Krugman discusses with Richard Quest (22/2/21)

Questions