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Economic stimulus – caught between a rock and a hard place

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Op-ed views and opinions expressed are solely those of the author.

It appears that President Trump and Congress will agree to a massive economic stimulus package to offset the negative effects of the Coronavirus.  Many believe the economy has already entered recession, so the stimulus is needed.  The problem is that the stimulus will cause the annual budget deficit to hit $2.5 trillion this year.  Is the massive stimulus a good idea?

The public debt, which is the accumulation of all deficits, already exceeds $22 trillion.  That’s almost 10% more than annual GDP.  Historically when the public debt exceeds annual GDP, economists get very nervous, because the long term implications could be very troublesome.

Is the economy in a recession?

Most economists believe that we are either in a recession or about to enter one.  Since the federal and state governments have instructed so many people to stay home from work and for most service businesses where people congregate to close, the economy is tanking.  But will it lead to recession?

Historically, the technical definition of a recession is when at least two successive quarters of the year show negative growth.  More recently, the National Bureau of Economic Research (NBER) decides when the economy is in recession, often using a slightly different measure.

January and February of this year were generally good.  The economy was heading for 2.5% to 3% growth for the quarter, when this disaster struck.  Now since the economy has stagnated in most of March, the first quarter GDP number will likely be in the .5% to 1% growth range.

It is difficult to predict the growth in the second quarter.  Since the economy will remain stagnated at least in April, growth in the second quarter could be negative.  But it depends on what happens in May and June.

Once possible scenario is that because of the preventative measures now be taken,  the number of new cases peaks in late April.  That means beginning in May businesses will re-open.  Cancelled professional sports may return for their playoffs.  Many other events that were postponed in March and April, will be held in May or June.

That could mean the third quarter shows positive growth, and technically there was no recession.  Meanwhile, mortgage rates will drop to 3% or less.  Gas prices will fall to under $2 per gallon and the government will stimulate the economy using both Monetary and Fiscal Policy.

That could mean rapid growth in the third and fourth quarters, thereby skipping a recession. Of course, that scenario may be too optimistic.  If the negative economic impact of the coronavirus lasts well passed April, then the second and third quarters could show negative growth and we could be in a somewhat severe recession.

The government wants to avoid that scenario, so they are taking drastic action today.  The Federal Reserve has increased the money supply by more than a trillion dollars and has dropped the Federal Funds rate to near zero.  This is a very expansive monetary policy.

The economic stimulus packages being discussed will cost between $1 and $1.5 trillion.  That will be added to the already $1 trillion deficit.  In addition tax revenue will fall if a full blown recession does occur.  Adding that up, we have a deficit well in excess of $2.5 trillion.

What is the right course of action today?  Do we need a $1 trillion stimulus package?

The answer is very difficult.  Indeed, the federal government is caught between a rock and a hard place.  On one hand we want to avoid a deep recession, even if it is short lived.  On the other hand we can’t afford to have a $2.5 trillion deficit.  The consensus view from politicians in both parties seems to be to err on the side of caution and do whatever is necessary to avoid a deep recession.

That means massive stimulus packages will be passed.  The deficit will balloon to at least $2.5 trillion.  Fortunately, it is not a structural deficit so in 2121 that extra spending will go away and the deficit will be reduced.  Even so, we will still be stuck with at least a $1 trillion annual deficit.

President Trump will likely deal with this after his re-election in the Fall.  It will be easier for him, if the GOP regains the majority in the House of Representatives and maintains the GOP majority in the Senate.  As events play out this could be a very likely scenario.

Unfortunately, since more than 60% of federal spending is for Social Security, Medicare and Medicaid, and about 10% is for interest on the public debt, cutting spending will be difficult.  Raising taxes won’t work either, because the higher tax rates will slow economic growth, especially if taxes are raised on the wealthy.

Over taxing the wealthy destroys capital formation.  In a capital intensive economy that will lead to stagnation and lower, not higher, tax revenue.

Of course the only solution is to raise the retirement age for both Social Security and Medicare to at least 70 and likely 72 or 75 in the future.  This won’t effect anyone currently receiving benefits, but it will minimize spending on those programs.  It will also increase revenue.

Stimulating the economy today is a good idea to avoid recession.  Stimulating the economy through massive increases in government spending is a bad idea that will cause the public debt to soar.

It’s tough being stuck between a rock and a hard place.

Michael Busler

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