The US economy is facing a new challenge that has its roots in growth arithmetic: what fiscal impulses take away fiscal impulses.
The US $ 1.9 trillion rescue plan passed in March and a $ 900 billion pandemic relief package passed in December are well advanced. They were set up to get money out the door quickly. One consequence of this strategy, however, is that fiscal policy will reduce economic growth in the coming quarters.
Economists mainly assume that with strong labor market momentum and huge pent-up household savings, the economy will be strong enough to continue growing despite the easing of the fiscal hike. To avoid an economic downturn, a major handover from state-driven demand to the private sector must take place.
The mainstream view is that this will be successful. But there are aspects of this unusual economic moment that could bump the road ahead.
There is no modern precedent for such enormous sums of money being pumped into the economy by the government. And there is a risk – recently recognized by a top Federal Reserve official – that if the pandemic-era savings are disproportionately held by the wealthy, they will be sitting on that money instead of spending it.
“We’re definitely going to see a huge drop in fiscal incentives,” said Nancy Vanden Houten, senior economist at Oxford Economics. “The question then is how well the economy is set up for it, and we don’t know exactly what applies to so much in this time that we are going through.”
Most Americans who should receive $ 2,000 per person stimulus checks have already received them. The Treasury Department announced this month that $ 395 billion of that cash is now being shipped, slightly more than payments under the US bailout plan would cost if it were passed.
While unemployment insurance payments remain high, those expenses will also be reduced when people return to work – and additions to these payments are due to expire in September. Much of the other spending was either short-term, focused on things like getting vaccines up and running, or in very gradual fashion, such as an expanded child tax credit and grants to state and local governments.
Overall, government spending contributed 8.5 percentage points to economic growth in the first quarter, according to calculations by the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy. However, it is forecast that these so-called fiscal effects will be slightly negative in the second and third quarters – and then slow growth significantly in the fourth quarters of 2021 and 2022.
By the second quarter of 2022, fiscal policy is well on its way to subtracting 3.3 percentage points from the growth rate, significantly more than the 2.2 percentage point subtraction in the third quarter of 2011, the most extreme quarter of the last post-stimulus overhang of the previous recession.
That could change depending on where the negotiations on infrastructure and family support policies lead, but these policies are expected to influence fiscal policy over many years – they are reloaded rather than brought forward – so they shouldn’t radically change the near future .
The case for staying calm even if federal spending collapses is based on the rapid growth of the private sector in recent months.
Employers are increasing their payrolls at breakneck speed, so rising pay should support consumer spending even if government support lapses. Companies report an expansive mood that bodes well for investment spending. And overseas economies should start moving forward as other countries achieve wider vaccination, which would be good news for American exports.
“I think the basic story is that the economy is opening up again, so it can stand the fact that this stimulus is running out,” said Louise Sheiner, senior fellow at Brookings.
Additionally, Americans are sitting on a huge pool of savings from money they did not spend on things like travel and restaurants during the pandemic. Households have saved an average of $ 282 billion per month since March 2020, compared to $ 103 billion in 2019.
So a big question for the economy in the second half of 2021 and 2022 is what will happen to those cumulative additional savings of $ 2.5 trillion. Will it support short-term spending enough to keep growth on a strong path, or will Americans prefer the convenience of an increased balance sheet instead?
This is where the distribution problem arises. To the extent that money is held by financially wealthy people, they are less likely to spend it and stimulate the economy.
“Today’s fiscal tailwind is expected to shift into headwinds next year,” said Lael Brainard, a Fed governor, in a speech this month. “An important question is therefore how much household spending will support growth in the next year as well, instead of settling down on prepandemic trends.”
On the other hand, the rapidly shrinking fiscal boost could help ease the inflationary pressures that have built up in the economy. Whatever your make of the decision to send $ 2,000 to people, there will be no more checks to fuel demand and fuel an inflation cycle.
Ultimately, this is yet another example of how unusual the pandemic-fueled economy is. The only real historical comparisons with the types of increases in government spending over the past five quarters are with the beginning and ending of wars, which have their own economic dynamics.
So it pays to watch closely what happens when the federal government pulls back and whether American consumers and businesses, as well as importers from around the world, meet forecasters’ expectations.