The author is professor of finance at the University of Chicago’s Booth School of Business
Is inflation the chief risk arising from colossal levels of US public expenditure during the pandemic? Spending has been spurred by a belief that, as long as the federal government can borrow without a rise in low interest rates, no one really needs to pay. In case markets disagree, the rich can be taxed.
However, with populations ageing and potential growth slowing, the notion that industrial countries can allow their sovereign debt to grow indefinitely at even the more moderate pre-pandemic pace seems optimistic. Past experience suggests it will be hard to make the rich pay — they will oppose new taxes vigorously and avoid them if implemented. If the $5tn of US spending so far enacted eventually requires ordinary taxpayers to bear some burden, its lack of targeting or restraint will have adverse consequences.
Defenders of the spending point to tepid inflation over the past decade and the Federal Reserve’s inflation-fighting credibility. Worriers point to the unprecedented levels of spending relative to unused economic capacity, and the Fed’s stated determination to be patient even if inflation rises. But in such unusual circumstances, no one can be confident how inflation will play out.
Clearer, though, is that all manner of spending has been justified on the grounds that the government can and should offer relief to the pandemic-affected. Undoubtedly, government should help those hit hardest in times of calamity. For example, it makes sense to extend unemployment insurance when local jobs are scarce because of Covid-related shutdowns, or to expand food or rent support to the poor.
But losses are part and parcel of business, even if they are pandemic-related or government policy-induced. Badly designed grants to small and medium-sized businesses may end up subsidising entities that do not need support. Is a rich dentist, who will surely recoup much of her lost business when the economy reopens, as deserving of help as the community arts co-operative in a distressed neighbourhood? What if that grant goes simply to repay her banker?
Least deserving of support are large companies like airlines. Those should go through bankruptcy if they are in financial difficulty, as they have in the past. That lets them write down their debts while continuing operations. Yet even these have been aided on the specious grounds that their financial distress would hold back economic recovery. Businesses have suffered in the pandemic, but so has the ordinary taxpayer. If government transfers to businesses are not essential for their survival or growth, they are unfair gifts from the ordinary taxpayer to the (often wealthier) shareholder, and will undermine spending’s political legitimacy.
In a recession, another rationale for spending is to stimulate economic growth. We are not, however, in a normal downturn. Pent-up savings will fuel demand for travel, restaurants and hotels as the economy reopens. A fair amount of these savings derives from people’s inability to spend when stuck at home. Was more largesse really needed?
And could it have been better targeted? Stimulus cheques are lifesavers for poor households, and will be spent on goods and services. But the fiscal multiplier is likely to be small when a worker making $70,000 a year uses his cheque to invest in cryptocurrencies. Retirees, who saw no abatement in their incomes, are also unlikely to spend windfall cheques.
By contrast, the US needs to spend on bridges, broadband and charging stations, on improving the capabilities of its people and even on upgrading the technology supporting state unemployment systems. By increasing the potential growth of the economy, and reorienting it towards the future, such spending could pay for itself. Unfortunately, this is likely to be most contentious, since Congress now aims to raise revenues to pay for investment.
Why only now? In the early days of Covid-19, it was necessary to act fast to stop serious damage to the economy, given the unknown scale of the crisis. But in later spending packages, politicians arguably did not want the populist goodies they were targeting at their constituencies to be assessed in the sobering light of the need to pay for them.
The newly emerging fiscal caution of Congress comes after a riot of spending. Unfortunately, the unwillingness thus far to be fiscally responsible could constrain even essential investment. And the frequency with which we are experiencing “once-in-a-century” crises suggests the cost to future generations of our eating up their fiscal room could be substantial. Inflation is not the only risk in recent US fiscal behaviour.