As George mentioned this morning, the idea that large spending legislation can lead to prosperity is problematic, to say the least.
But even if you are sympathetic to the idea that government spending can stimulate the economy, there is no way to justify the size of the American Rescue Plan, a plan that has little to do with rescuing us but is a first step toward a progressive paradise á la Bernie Sanders, at least with the tradition tools used by Keynesian or even neoliberal thinkers.
That level of spending has nothing to do with the traditional justification of filling the economy’s output gap, the difference between actual economic activity and potential output in a normal economy, unless we are willing to recognize that the economic return on this government spending (the spending multiplier) is ridiculously small — much smaller than 1.
Let’s do the math: The Congressional Budget Office projects that the output gap will be $700 billion through 2023, the period when most of the $1.9 trillion in spending will take place. It means that $1.9 trillion is two or three times more than needed to fill the gap. Unless one is willing to say that the multiplier is roughly 0.37. For each dollar the government spends (and takes from the real economy), it gets $0.37 in growth. Not too glorious.
Talking of spending multipliers, the economists at Penn Wharton looked at that issue and estimated the macroeconomic effects of the latest $1.9 trillion stimulus. The projections include estimated fiscal multipliers. Here is what they found (first number is the low estimate; second is the higher estimate):
- Purchases of goods and services by the federal government = 0.2 / 0.8
- Transfer payments to state and local governments for infrastructure = 0.1 / 0.7
- Transfers to persons (unemployment benefits, education transfers, and food stamps) = 0.1 / 0.7
- Transfer payments to state and local governments for other purposes = 0.1 / 0.6
- Business tax provisions primarily affecting cash flow = 0 / 0.1
Overall, the average fiscal multiplier of the American Rescue Plan is: 0.14 for low estimate and 0.56 for high. It means that, if you use a 0.14 multiplier with $1.87 trillion in spending, you get $260 billion in additional output — a.k.a. a net loss of $1.61 trillion for the private sector. If you use 0.56, you get $586 billion in addition output. Not too stimulative.
But I guess trying to justify the size of the spending package with such techniques is too 2020. The justification for the size of the package is not that it’s a stimulus package, but that it is a rescue package. A $1.9 trillion rescue from what, I am not sure, since most of the package didn’t have much to do with the pandemic. Also, as with the previous COVID relief bills, the payments to individuals went above and beyond income and wages lost or went to people independently of how affected by the pandemic they were.
Meanwhile, I will continue to echo the 2009 warning from Harvard’s Robert Barro:
If, as I believe to be true, fiscal deficits have only a short-run expansionary impact on growth and then become negative, the results from following this policy advice are persistently low economic growth and an exploding ratio of public debt to GDP.