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Policymaking in a Pan(dem)ic – by Stephanie Kelton

As many of you know, I co-host a weekly podcast for MarketWatch. It’s called Best New Ideas in Money and each episode is about 25 minutes long. It’s perfect for a quick workout, a brisk walk with the dog, or running a couple of errands. You can subscribe to the program here.

I spoke with ADP’s chief economist last week in him Richardson on inflation, the labor market and the economic outlook for 2023. You can listen to this episode after the holidays.

We’ve also been working on a topic I’ve been wanting to cover for a while: automatic stabilizers. You can think of automatic stabilizers like the shock absorbers in your car. No need to push a button or pull a lever to engage them. If the road becomes bumpy or bumpy, the shock absorbers will automatically cushion your ride. They don’t guarantee a perfectly smooth ride, but they will cushion some of the harsher impacts as road conditions change.

Shift gears, pun intended, we’ve equipped our economy system with various stabilizers designed to automatically respond to changes. economic conditions For example, in a slowing economy, more people are eligible for unemployment insurance and food stamps, so government spending automatically increases in these categories of the federal budget. Meanwhile, tax receipts automatically decline as the weak economy leaves corporations and individuals with less taxable income. With higher spending and lower tax revenue, the federal deficit automatically increases. The larger deficit cushions the economic slowdown. In a booming economy, the opposite happens. (Click here allowed.)

If we didn’t have the automatic stabilizers, we would have to rely on some combination of discretionary monetary policy and fiscal policy to counter fluctuations in output, employment and inflation. This would leave us worse off because: (a) Congress might be unwilling to pass discretionary legislation to adjust spending and/or taxes as needed to help stabilize the economy; (b) the Federal Reserve could struggle to restore full employment and price stability on its own.

This is exactly what happened after the financial crisis of 2007/08.

Congress then mustered the votes to pass a discretionary tax package known as the American Recovery and Reinvestment Act (ARRA), while the Federal Reserve lowered the overnight interest rate to zero and launched several rounds of large-scale asset purchases (LSAPs) known as “quantitative easing” (QE). What looked, to some, like a massive counter-offensive The Great Recession did relatively little to avoid a downward spiral.

Ironically, what ended up saving our bacon were the things policy makers didn’t have to do choose do.

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In June 2009, the US economy officially out of the recession. The following month, Paul Krugman published a column declaring: “Deficits saved the world.” But as Krugman (and others) rightly pointed out, the slowdown was stopped not so much by the relatively small deficits that occurred through the discretionary fiscal package, but by the large deficits that occurred because of the automatic stabilizers. Here is Krugman:

[G]Government deficits, mainly the result of automatic stabilizers rather than discretionary policy, are the only thing that has saved us from a second Great Depression. . . without the absorbing role of budget deficits, we would have had a full experience of the Great Depression. What we’re actually having is horrible, but not that horrible, and it’s all because of increasing deficits. Deficits, in other words, saved the world.

Looking back on that period, Martin Wolf of the Financial Times argues that a stronger fiscal response would have been even better. Unfortunately, too many governments pivoted towards austerity, prematurely withdrawing (discretionary) fiscal support from their economies. The result was an anemic “recovery” with devastating effects in the labor market.

[I]In order to maintain demand when the private sector has been hit as hard as it was in 2007 to 2009—and this seems to me to be the most fundamental lesson that Keynes tried to introduce when he was thinking about depressions—governments need to be big. deficits . .

And unfortunately, in basically every country, including the US for various reasons, that tax support was cut back too soon in my opinion. And that meant the recovery was not sustained. As the recovery was not sustained, the business became more cautious. So he did [the recession] long-term.

Now, in the long term, we need to create a stronger financial system, a less leveraged economy and a more balanced world economy. These are big challenges. I believe we have not taken the necessary steps to make our economy stronger.

One way to make our system more robust is to strengthen the automatic stabilizers so that fiscal deficits are set in motion with an even stronger countercyclical response to changing macroeconomic conditions. I emphasized the need for stronger automatic stabilizers in my book, The deficit mythi other MMT scholars have proposed innovative ways to further automate policy response.

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In his final speech in Jackson Hole in 2016, Fed Chair Janet Yellen focused on the past, present and future of monetary policy, but she also said something important about fiscal policy:

Beyond monetary policy, fiscal policy has traditionally played an important role in dealing with severe economic downturns. A wide range of possible fiscal policy tools and approaches could improve the cyclical stability of the economy. For example, steps could be taken to increase the effectiveness of automatic stabilizers, and some economists have proposed that more useful fiscal support could be provided to state and local governments during recessions.

At the same time, San Francisco Fed President John Williams said:

If we could come up with better fiscal policy … then that takes away from the pressure to try to find other ways to do it, like through a big balance sheet. It also means that we don’t have to resort so much to quantitative easing and other policies.

What Yellen and Williams (i Ben Bernanke) were saying is that monetary policy is not enough, especially when we are facing a strong economic recession. But if Congress refuses to use its own policy (fiscal) leverage strongly enough, then all the work will be left to the central bank, and that means making all kinds of policy interventions (like ZIRP or QE) that most central banks would prefer to avoid.

Whereas the lesson of 2007/09 is that we couldn’t get it enough discretionary fiscal policy to restore full employment in a timely manner, some argue that the lesson of 2020/21 is that we have too discretionary fiscal support: three rounds of stimulus checks, enhanced unemployment insurance of $600 a week, PPP loans, etc. I will not re-litigate this latter debate here. The reality is that it took nearly 7 years to recover the roughly 9 million jobs lost in the Great Recession, but only 2.5 years to restore the 22 million jobs lost in the Great Recession covid I’ll take the second performance over the first any day of the week.

We did better this time not because we had better Federal Reserve policy. In fact, we got pretty much the same as after 2008, namely zero interest rate policy (ZIRP) and massive bond buying (QE). We did better because Congress delivered not one, not two, but three substantial pieces of legislation actively supported the economy with about $5 trillion in additional spending.

And so, once again, deficits saved the world. But this time the deficits increased not primarily because of congressional inaction—that is, the automatic stabilizers—but because of the proactive—that is, discretionary—actions of Congress and the White House.

Did they get everything right? No. Did we need all 5 trillion dollars? Probably not. Could some of this spending have been better targeted? You bet Should some of them have been planned to be phased out earlier? Probably.

But remember that the three largest packages ($2.2 trillion in March 2020, $900 trillion in December 2020, and $1.9 trillion in March 2021) were approved in the midst of a global pandemic. For better or worse (I think it was for the better), lawmakers decided it was better to err on the side of doing too much rather than doing too little.

In the future, we should try to avoid cobbling together multi-trillion dollar tax bailouts in a panic. One way to do this is to start strengthening our automatic stabilizers. An old rule of thumb advised drivers should consider replacing their vehicle’s shock absorbers every 50,000 miles or so. When it comes to our budget shock absorbers, we’ve been long overdue for an update.

Happy Holidays and please consider subscribing to the podcast.


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