The 1.9 Trillion-Dollar Question

Mariano Torras Economic Theory, Environment/Sustainability, General, Macroeconomics, Politics, Public policy/Wellbeing Leave a Comment

February 14, 2021

The truth is that approval of the Biden Administration’s proposed stimulus package is inconceivable without major revision. We know that. But let us for the moment ignore the partisan political challenges that make passage impossible. Pretend, in other words, that Congress is unified and ready to rubber stamp whatever plan Biden advances. The 1.9 trillion-dollar question then becomes whether the size of his present proposal is too large – or not large enough. The political arguments on each side are by now entirely familiar. But what about the economics?

Former Treasury Secretary and Director of the National Economic Council Larry Summers fears that $1.9 trillion would be overshooting the mark, with adverse inflationary effects likely. As he sees it, the resulting magnitude of the boost to GDP would be multiples of the present estimated output gap, possibly leading to double-digit inflation. But as even he recognizes, estimates of potential GDP and the output gap are notoriously unreliable. And under present volatile conditions they are without doubt even more dubious. 

Also, as noted by German Lopez, what Biden and his camp are proposing is more of a genuine relief package than a stimulus. A very important distinction, that. It is difficult to imagine additional money spent paying for provisions, back rent, and the like generating much inflation. And there is little indication that the so-called “middle” class (or what is left of it) would suddenly tack and go on a spending spree. High uncertainty will be with us for the indefinite future, and people tend to be extra cautious in such times.

Dean Baker, moreover, argues that the upside potential of Biden’s proposal is much greater than the downside risk. What, in other words, is the worst that could result from too much stimulus? Something like what we saw in the 1970s, perhaps? In Baker’s own words, the decade of the 1970s “wasn’t that bad” [since] “we didn’t have mass starvation or homelessness.” Certainly, I could imagine much worse things than 12 percent inflation unless, of course, I were in the “high net worth” category.

And even moderate inflation would be the worst-case scenario. As I have commented elsewhere, while global inflation appears likely to rear its head due to inexorable demographic changes, we should not expect it any time soon. In the short- to medium-term, deflationary headwinds are likely to dominate. All the more reason to err on the side of too much.

And it is not even clear what “too much” means, or if there is even an upper limit to what might produce a net positive outcome. Proponents of modern monetary theory have long argued that it is wrong to think in terms of government budget limits. They believe, in short, that the Central Bank’s power to authorize the creation of money gives free reign to governments to pursue their expansionary goals. Were inflation to appear as the economy approached full employment, the government could readily tax away the excess money in circulation. Against all odds, the claims made by modern monetary theory appear to be making it into the mainstream.

There is little question that with a new Democratic government in place, Republican deficit hawks will reappear in Congress. But in desperate times like the present, we are dangerously misguided in our focus on the Federal deficit. The punchline? $1.9 trillion is, at best, a good start. The Biden Administration must seize what amounts to a golden opportunity to redirect the U.S. economy in a major way. Future policy must better provide for the majority, create jobs, and help reduce the stress on the global environment. Did someone say Green New Deal? More on this in my next post…

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.