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Economic stimulus: Is a large increase in the deficit really a good idea?

Written By | Mar 19, 2020
economic stimulus, deficit

Cartoon by Garrison, reproduced with permission and by arrangement with Grrraphics.com.

WASHINGTON — It appears that President Trump and Congress will agree to a massive economic stimulus package to offset the negative effects of the coronavirus epidemic. Many analysts and economists believe the economy has already entered a recession, so the country clearly needs a stimulus program. But the final economic stimulus package or packages will cause the annual budget deficit to hit $2.5 trillion this year. Is such a massive stimulus a good idea?

The US public debt, defined as the accumulation of all deficits, already exceeds $22 trillion. That’s almost 10% more than the country’s annual GDP.  Historically, when the public debt exceeds annual GDP, economists become very nervous. They know the long term implications of such a deficit may prove very troublesome.

Is the US economy in a recession?

Most economists believe that we are either in a recession or about to enter one. Since the Federal and state governments have instructed so many people to stay home from work and for most service businesses where people congregate to close, the economy has begun to tank. But does that necessarily lead to a recession?

Historically, the technical definition of a recession states that it occurs when at least two successive quarters of the year show negative growth. More recently, the National Bureau of Economic Research (NBER) determines when the economy is oficially in recession. But the NBER often uses a slightly different measure.




January and February of this year were generally good, economically speaking. The US economy was heading for 2.5% to 3% growth for the first quarter when twin disasters struck. Specifically the coronavirus crisis and the surprise Saudi-Russian oil price war. So now, since the economy has already stagnated throughout most of March, the first-quarter GDP number will likely drop to the 0.5% to 1% growth range.

Predicting the growth rate — if any — in the second quarter will prove difficult. Since the economy will likely remain stagnant at least through April, growth in the second quarter could come in as a negative number. But it all depends on what happens in May and June, which conclude the second economic quarter of 2020.

How long will the current economic problems last?

One possible scenario envisions that due current and future preventative measures taken by the government, the number of new coronavirus cases may reach its peak in late April. That means beginning in May, most businesses will re-open.  Canceled professional sports may return for a slightly extended season or for their playoffs. Many other events postponed in March and April, will likely be held in May or June.

That could result in the third quarter returning to positive growth. Thus, technically, the country may avoid experiencing a recession. Meanwhile, mortgage rates, once the economy stabilizes, may drop to 3% or less. Due to the ongoing and indefinite oil price war, the price of gas at the pump in the US would fall to under $2 per gallon. At the same time, the government’s evolving stimulus program will bost the economy through the nation’s monetary and fiscal policies.

That might mean the country would experience rapid growth in the third and fourth quarters of 2020, thereby skipping a recession altogether. Of course, this scenario may prove too optimistic. If the negative economic impact of the coronavirus lasts well past April, then the second and third quarters of 2020 could show negative growth, meaning that by summer, we could be in the throes of a moderately severe recession.

The government wants to avoid that scenario, which is why official Washington began taking drastic action this week. The Federal Reserve Bank has already increased the money supply by more than a trillion dollars, and has dropped the Federal Funds rate to near zero as well. This kind of economic stimulus action amounts to an extraordinarily expansive monetary policy. The currently developing policy, in fact, already rivals the policies put in place to stem the tide of the Great Recession.

The fiscal stimulus package.

The economic stimulus packages under discussion may cost between $1 and $1.5 trillion. The government would add that number to the already $1 trillion US deficit. In addition, tax revenue will likely fall if a full-blown recession does occur.  Adding that up, would result in a deficit estimated well in excess of $2.5 trillion.

What is the right course of action today?  Do we need a $1 trillion economic stimulus package? That’s a difficult question. The Federal government finds itself caught between the proverbial rock and a hard place.


Also Read:  Price controls: Definitely not the answer to escalating healthcare costs

On the one hand, the government wants to avoid a deep recession, even a short-lived one. On the other hand, the US can’t afford to have a $2.5 trillion deficit when the already existing deficit remains too high on its own. The consensus view from politicians in both parties? Err on the side of caution and do whatever the government can do to avoid a deep recession.

That means that Congress will pass massive economic stimulus packages, and the Federal deficit will quickly balloon to at least $2.5 trillion. Fortunately, the additional debt level does not constitute a structural deficit. So in 2121, that extra spending goes away and the deficit shrinks. Even so, the country will still be stuck with at least a $1 trillion annual deficit.



President Trump will likely deal with this deficit after his re-election in the Fall. Another term would make it easier for him should the GOP regain the majority in the House of Representatives and maintains its GOP majority in the Senate. As events play out this may prove a very likely scenario.

What about entitlements programs?

Unfortunately, more than 60% of federal spending is for Social Security, Medicare and Medicaid and about 10% is for interest on the public debt. But cutting spending will prove difficult.

Raising taxes won’t work either. The higher tax rates would slow economic growth, especially if the government raises taxes on the wealthy. Overtaxing the wealthy destroys capital formation. In a capital intensive economy that will lead to stagnation and lower, not higher, tax revenue.

Of course, the only solution to this problem is to raise the retirement age for both Social Security and Medicare to at least 70, and likely 72 or 75 in the future. This would not affect anyone currently receiving benefits. But it would minimize spending on those programs. Additionally, it would also increase revenue.

Stimulating the economy today is an excellent strategy to avoid a recession. Stimulating the economy through massive increases in government spending is generally a bad idea that will cause the public debt to soar.

It’s tough being stuck between a rock and a hard place. But that’s where we are right now.

— Headline image:  Where have we heard about this kind of stimulus plan before?
Cartoon by Garrison, reproduced with permission and by arrangement with Grrraphics.com.

 

Michael Busler

Michael Busler, Ph.D. is a public policy analyst and a Professor of Finance at Stockton University where he teaches undergraduate and graduate courses in Finance and Economics. He has written Op-ed columns in major newspapers for more than 35 years.