- Economists aren’t just watching the size of the stimulus package. They’re watching whether it’s enough to close the “output gap” — the difference between how quickly the economy is growing and how quickly it could grow in optimal conditions.
- Some 400,000 small businesses have closed permanently, and millions of Americans are in poverty.
- Lawmakers should go big on fiscal stimulus, while dialing down monetary support to the economy.
There is a contentious debate brewing among Democratic economists who span the Clinton, Obama and, now, Biden administrations that is focused squarely on the size and composition of the president's $1.9 trillion Covid-19 relief plan.
At the heart of the debate is not just the size of the package but whether it is sufficient to close what economists call "the output gap."
The gap is the difference between how quickly the economy is growing and how quickly it could grow under optimal conditions.
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It's not a purely academic argument, though several academic papers have already been published about it, along with a stream of op-eds in major newspapers.
The outcome of the "output gap" debate also has large implications for Wall Street, even if the assistance is aimed at Main Street.
Some argue that the $1.9 trillion plan may not necessarily be too large, so long as it swaps some of the components of the plan to focus on public investments rather than just stimulus checks, state and local aid and unemployment benefits.
They reason the economy has recovered faster than expected, given the unprecedented stimulus provided by the Federal Reserve, the $2 trillion CARES Act and the most recently approved $900 billion aid package, not to mention the historic development and distribution of vaccines.
There are also fears of unintended consequences of too much stimulus, one of which could be inflation, while also voicing concerns about financial stability.
We've seen evidence that both could or have already become issues. (See trading in GameStop and SPACs.)
As for inflation, the five- and 10-year inflation breakevens, an indicator of rising inflation expectations, have risen above 2% from 0.5% a year ago. Bad news for bonds, good news for commodities and other "hard assets."
The historic amount of stimulus injected into the economy has pushed up consumer spending and savings — even as large numbers of people remain unemployed, underemployed or have left the workforce altogether.
Go big or go home
While I am somewhat sympathetic to the argument that the package might be too big, I tend to side with the "go big or go home" group, and it may not be for reasons some would expect.
(It's not just to launch another large-scale program full of progressive initiatives.)
First, I believe that reconstructing the Biden plan to include public investment in infrastructure, at this stage, would be politically impossible, despite bipartisan support for those critical investments.
Second, I believe that before we spend on infrastructure, the nation needs an exhaustive discussion on what type of infrastructure — beyond roads, bridges and tunnels — is appropriate for a 21st and even 22nd century economy.
Finally, and I'm burying the lead here, are we measuring the "output gap" properly?
The economy has undergone an extremely rapid transformation amid the pandemic.
The Biden plan shows that some 400,000 small businesses have permanently shuttered their operations.
Some 50 million Americans are food insecure, and 20 million are receiving public assistance from unemployment checks to food stamps. Eight million have plunged into poverty, a record number at a record pace.
That's output that may be permanently lost.
How do you assist a small business that has shuttered its doors for good? It's not just lost wages, but lost household wealth that will affect many families for the rest of their lives.
This, I believe, is a critical issue. While new owners may open businesses where others once stood, the prior owners may be permanently hampered by an inability to build back better.
Meantime, the work-from-home phenomenon is likely here to stay while bricks-and-mortar retail and traditional offices face secular headwinds.
Hospitality, leisure and travel, while poised to rebound, are not expected to return to full capacity for years, if ever.
Further, given the communications technology available, there is likely a major glut of office space, a permanent reduction in business travel and other major dislocations that may well last a long time.
Against that backdrop, how then do we know if we are spending too much or too little to bring the economy's growth rate back to its fullest potential.
Yes, we will recover. Yes, the rapid deployment of vaccines and therapeutics will bring a return to some semblance or normality faster than some had suggested.
But some "output" will have been lost for good.
My own suggestion would be to go big on fiscal stimulus while dialing down monetary support to the economy.
This would reduce the risk of budding monetary inflation and restore some more normal behavior to financial markets.
We no longer need fiscal and monetary policy simultaneously operating at full tilt.
The Fed has largely accomplished its goals of supporting the economy through the pandemic.
It can remain accommodative without adding any further fuel to the coming economic fire.
Rates can stay at zero for some time to come, but additional stimulus, or quantitative easing, can take a breather.
Yes, there will be a "taper tantrum" on Wall Street, but the focus of fiscal policy needs to be squarely placed on the depression landing disproportionately on Main Street.
If Main Street can fully recover sooner rather than later, Wall Street will be just fine. In fact, the market is telling us the larger the package, the more likely it is the bull market has more room to run.
Go big, get bullish, or go home!