COVID-Related Spending Must Not Become an Excuse for a Post-Crisis Fiscal Straitjacket

Writing for the Brookings Up Front blog, Stuart Butler and Timothy Higashi urge fiscal policymakers to look beyond the current crisis. Extraordinary short-term spending is justified, they agree, but, they urge that “we also need to put in place – ideally as part of ongoing stimulus measures – procedures that will help policymakers and the public to prepare for the less urgent but equally important task of managing the future fiscal and economic threats from today’s emergency actions.”

They are right that we need better long-term fiscal rules to avoid long-term budget chaos. Even more importantly, we need good rules to avoid premature austerity that could slow the recovery, as happened half-way through the rebound from the 2008 financial crisis. But just what should the rules look like?

Above all, in my view, any such rules must not become a fiscal straitjacket that would impair our prosperity for years to come. The once-popular notion of a balanced budget amendment is a classic example of what we do not need. A rule requiring annual budget balance would be profoundly procyclical. It would require cutting expenditures when tax revenues fell during a slump, and in boom times, it would put no real constraint on tax giveaways like the 2017 Tax Cuts and Jobs Act.

No one seems to be pushing a balanced budget amendment now, but some ideas that are floating around would not be much better. One example is the Enzi-Whitehouse plan (S.2765), which Butler and Higashi are a good deal warmer toward than I am. As I read it, the central pillar of the Enzi-Whitehouse plan is a hard cap on the debt-to-GDP ratio that could be overcome only by a supermajority. Unless the bill were very carefully crafted, it would become a de-facto balanced budget requirement as soon as the debt ceiling were reached, which it inevitably would be. If the current draft of the bill contains safeguards to keep that from happening, I can’t spot them in the text.

Tired of the COVID-19 Lockdown? Here is a Responsible Reopening Plan

People are getting tired of the COVID-19 lockdown. Surveys show that a majority still put a greater priority on protecting public health than on reopening the economy, but either way, we would all prefer to do both. A plan released yesterday from the Harvard-based Safra Center for Ethics shows that is possible, if we are willing to take the necessary steps.

The Roadmap for Pandemic Resilience (“The Roadmap,” in what follows) is not the first try at finding a way to safely reopen the economy, but it outclasses all previous attempts with its a realistic timetable, fact-based quantitative benchmarks, and a detailed institutional structure. By comparison, the vague guidelines offered by the White House are little more than slogans and aspirations. Here are the key features that distinguish The Roadmap from other reopening plans:

Testing. The White House talks of expanding testing from its current rate of 150,000 or so a day to 300,000. That is barely enough to test people who have severe symptoms, let alone enough to test nonsymptomatic essential workers to make sure they do not spread the virus or to conduct the random surveillance testing we need to know exactly where the virus is (and is not) in our communities. The Roadmap calls for 2 million tests a day, quickly rising to 5 million. Sound like a lot? Those numbers fall only in the middle of a range of credible testing estimates reviewed by the Kaiser Family Foundation, but they are enough if the right people are tested at the right times.

The Shaky Logic Behind Hopes for a Quick Recovery

President Donald Trump promises that the economy will soar "like a rocket ship" as soon as the COVID-19 pandemic ends. Writing for the Independent Institute, R. David Ranson, like many who fear the government more than they fear the virus, agrees.

“We ought to be thankful that the economic system is resilient in a way that the human body is not,” Ranson says. As the figure shows, he foresees a short, notch-shaped “interruption,” preceded by an anticipatory stocking-up surge and followed by a similar post-pandemic boomlet as shelves are restocked.

Ranson bases his hopes for such a growth trajectory on the notion that the interruption to production will destroy no physical capital.

[A]fter the production shutdowns end, GDP will shift back above pre-crisis trend as businesses and consumers make up for lost time. Events do not as yet add up to a significantly weaker full-year performance for the US economy. Economic activity will go into hiatus, but it can be made up quickly once the crisis is over.

As I explained in this earlier post, Ranson is right to say that pandemics, which hit the economy from the supply side, disrupt things in a very different way from ordinary recessions, which hit from the the side of demand. He is also right that clumsy, improvised public health interventions like universal stay-at-home orders do more damage than would more nuanced interventions based on the test-trace-isolate principle. Everyone knows that by now. We all hope that we will be better prepared for the next pandemic than we were for this one, so that the tradeoff between saving lives and saving the economy will not be so stark.

But Ranson misses some critical parts of the story. Although it is true that the virus does not destroy industrial equipment or commercial structures, it will destroy some very important intangibles if it goes on for long.

For one thing, it will destroy critical business relationships. Employer-employee relationships, supply-chain relationships, and lender-borrower relationships cannot necessarily be turned on and off without harm. It will take time to re-establish them, leading to slower recovery. Policies like payroll protection loans will help a little, but they are not a panacea.

A second problem is that even a temporary downturn will lead to widespread bankruptcies among the many firms and households who were over-leveraged going into the crisis. Fixed-payment obligations like bonds, mortgages, and leases cannot easily be suspended during the Ransom’s "interruption." Bankrupt business entities cannot instantly or painlessly be brought to life after the crisis is over, even if they were viable concerns to begin with, which not all were. Bankrupt consumers will have to limit their consumption for months or years as they rebuild their credit. State and local governments, whose revenues are falling, but whose fixed bond and pensions obligations remain, will have to undertake painful layoffs or tax increases. Either will be a further drag on the recovery.

Finally, Ranson completely misses, or is indifferent to, how unevenly the costs of the “interruption” will be distributed. People who work in restaurants and airports will be hammered, while those who staff grocery stores and Amazon warehouses may even see their paychecks swell with overtime. Investors who foolishly put their money in airlines or cruise ships will suffer badly, while those who invested in on-line service providers or makers of medical supplies will do well. Losses to the former will exceed gains to the latter. Inevitably, some whole communities will have more losers than winners. They will recover slowly.


In Ranson’s view, the greatest dangers we face from the pandemic come from “over-zealous efforts to quarantine and delay the spread of disease” and “a larger and more authoritarian central government unlikely to be scaled back afterwards.” In my view, the greater danger comes from those who tell us everything will be fine if we just stay calm and carry on.

Previously posted at NiskanenCenter.org. 

A Social Safety Net For an Age of Uncertainty

The COVID-19 pandemic is turning out to be a wake-up call, not just for public health, but for economic security, as well. We are learning that any one of us can be knocked off the ladder of prosperity at any time, no matter what rung we are on today.

What is more, COVID-19 is by no means the last crisis we are likely to face. Just a few things that may be coming down the pike:

• A really bad virus, one as contagious as measles and as deadly as Ebola. 
• Floods, wildfires, droughts, and famines brought on by climate change.
• A job apocalypse, in which entire middle-class occupations disappear one by one.

Meanwhile, none of the old risks are going away. The risk of being born poor, making even the first step to self-sufficiency precarious. The risk of being born with a disability or congenital illness. The risks of bad choices — dropping out of school; falling into crime; falling into substance abuse.

This crisis has shown everyone, left, right, or center, just how inadequate our fragmented social safety net is for dealing with what the world is throwing at us. Encouragingly, the first response has been a sound one: Send money, and send it fast. To think how radical the idea of universal cash assistance seemed, oh such a short time ago.

The idea that cash is what people need most when adversity strikes is far from new. Decades ago, Milton Friedman argued for programs that give help “in the form most useful to the individual, namely cash.” More recently, Charles Kenny cites examples from around the world in support of a simple policy recipe: “Give poor people cash without conditions attached, and it turns out they use it to buy goods and services that improve their lives and increase their future earnings potential.”

However, the current push for emergency cash assistance is ad hoc and impulsive. So be it. Get the first checks in the mail fast. But meanwhile, we should give some careful attention to designing a more orderly system of cash assistance, custom-tailored for an age of uncertainty. The requirements are clear: The new system should be seamless, work-friendly, and resilient. But what form should it take? A universal basic income? A negative income tax? Wage subsidies? This commentary examines each of these alternatives and concludes by recommending a reform program that including features of each of them.

The Macroeconomic Implications of the CARES Act

In response to the economic crisis caused by the COVID-19 pandemic, Congress has just passed a $2 trillion spending package, the Coronavirus Aid, Relief, and Economic Security Act (CARES). Although it was put together very quickly, the macroeconomic impacts of this fiscally enormous piece of legislation will be felt for years. The following commentary highlights some of its important macroeconomic implications.

Stimulus or lifeline?

Not surprisingly, CARES has been widely compared to stimulus measures enacted at the onset of the Great Recession — the Economic Stimulus Act of February 2008, the Troubled Asset Relief Program (TARP) of October 2008, and the American Recovery and Reinvestment Act of February 2009. Although the total cost of those three laws was comparable to that of CARES, the new law is differently targeted and will affect the economy differently.

One important difference is that the 2007-09 recession was largely the result of a massive shock to aggregate demand triggered by the contraction of lending and the collapse of housing prices. In this case, the initial shocks have come from the supply side, first in the form of interrupted supply chains, then as sick and frightened workers became unable to report to their jobs, and finally, the policy-induced shock of shelter-in-place orders. (See here for a detailed discussion of the difference between supply shocks and demand shocks.)

As a result, restoration of aggregate demand will not be enough to restart the economy. At least in the short run, the checks being sent out to individuals under CARES will be more important as social policy than as macroeconomic stimulus. In fact, if we go by the results of similar payments in 2008, it is likely that a substantial part of this round will go into precautionary savings, as a hedge against worsening of the crisis, or into debt repayment, which, in economic terms, is another form of saving. For many people, these payments will make the difference between moderate and extreme hardship, but they will do relatively little to induce an immediate rebound of GDP.

A further difference is that the 2008 crisis was triggered primarily by a meltdown of the financial sector. On the whole, banks have come into this crisis with much better capitalization than they had in 2007. Consequently, there is nothing in the CARES Act that is comparable to TARP, which was aimed at recapitalizing banks and other financial institutions. If trouble does again develop in the banking system (which we cannot rule out if the present crisis goes on long enough), then resolving it will require new legislation.

Quantitative Easing Alone will Not Cure COVID-19

The Federal Reserve is the nation’s first line of defense against recession. Unlike the Congress, which controls taxes and government spending, the Fed can make changes in interest rates on a moment’s notice — even late on a Sunday afternoon, as it did on March 15.

The Fed’s policy instrument of first resort is its control over short-term interest rates. The specific rate it normally targets is called the federal funds rate — the rate that banks charge to one another for overnight loans of funds held in their reserve accounts at the Fed. The price of borrowing reserves, in turn, strongly influences the rates at which banks are willing to make loans to businesses and consumers.

Despite the Fed’s close oversight, the effective federal funds rate is actually a market rate that varies from day to day according to changes in supply and demand. However, the Fed does not let the rate wander just anywhere. Instead, it sets policy targets in the form of upper and lower limits for the rate, usually a quarter of a percentage point apart. If a surge in demand for reserves threatens to push the effective rate through the upper end of the target range, the Fed supplies new reserves to the banking system by buying short-term securities. If demand weakens and the rate falls, the Fed withdraws reserves to limit the supply and keep the rate from falling through the floor.

The Coronavirus and the Economy: A Tutorial

The novel coronavirus that causes the disease COVID-19 will harm the U.S. economy. That we know, even though, as of this writing, the effects have barely begun to show up in statistics on employment, inflation, and real output. But just how bad will the impacts be, and what, if anything, can be done about them?

Although the economic effects of the virus will be complex, and we are sure to see some surprises, we can learn a lot from a simple model of the macroeconomy used in Econ 101 courses everywhere. This new slideshow presents a brief tutorial.

The model used in the tutorial is based on the concepts of aggregate demand and aggregate supply.

• Aggregate demand means the amount of real output – the inflation-adjusted quantity of goods and services – that consumers and firms want to purchase at any given time. Other things being equal, the quantity demanded is greater when the price level is lower.
• Aggregate supply means the quantity of real output that firms are willing to supply in response to the prevailing aggregate demand. Other things being equal, when demand increases, firms tend to react partly by increasing prices and partly by increasing the quantity of output.

When the economy is operating smoothly, as it was, for the most part, early in 2020, the rate of inflation is low and real output is close to potential GDP, which is the quantity of goods and services that can be produced in the long run without causing the economy to overheat.