The author is professor of finance at the Booth School of Business at the University of Chicago.
Is inflation the main risk arising from colossal levels of US government spending during the pandemic? Spending was driven by the belief that as long as the federal government can borrow without a hike in low interest rates, no one really needs to pay. In case the markets do not agree, the rich can be taxed.
However, with an aging population and slowing potential growth, the idea that industrialized countries can allow their sovereign debt to grow indefinitely, even at even more moderate pre-pandemic rates, seems optimistic. Past experience suggests that it will be difficult to get the rich to pay – they will vigorously oppose new taxes and avoid them if implemented. If the US $ 5 billion in spending to date enacted ultimately forces ordinary taxpayers to bear a certain burden, its lack of targeting or restraint will have adverse consequences.
Spending advocates point to lukewarm inflation over the past decade and the Federal Reserve’s credibility in fighting inflation. Concerns highlight unprecedented levels of spending relative to slack economic capacity and the Fed’s stated determination to be patient even if inflation increases. But in such unusual circumstances, no one can be sure how inflation is going.
Clearer, however, is that all the spending has been justified by the fact that the government can and should provide relief to those affected by the pandemic. There is no doubt that the government should help those hardest hit in times of calamity. For example, it makes sense to extend unemployment insurance when local jobs are scarce due to Covid-related closures, or to extend food aid or rent to the poor.
But losses are an integral part of doing business, even if it is linked to a pandemic or government policy. Poorly designed grants to small and medium-sized enterprises may end up subsidizing entities that do not need help. Does a wealthy dentist, who will surely recover much of his lost business when the economy reopens, deserve as much help as the community arts cooperative in a distressed neighborhood? What if this subsidy was simply used to reimburse his banker?
Large companies like Airlines companies. They should go bankrupt if they are in financial difficulty, as they have done in the past. This allows them to write down their debts while continuing their activities. Yet even these were helped on the specious grounds that their financial distress would hold back economic recovery. Businesses have suffered from the pandemic, just like the ordinary taxpayer. While government transfers to businesses are not essential to their survival or growth, they are an unfair giveaway from the ordinary taxpayer to the (often richer) shareholder and will undermine the political legitimacy of spending.
In times of recession, another rationale for spending is to stimulate economic growth. We are not, however, in a normal slowdown. Pent up savings will fuel demand for travel, restaurants and hotels as the economy reopens. Much of this savings comes from the inability of people to spend while stuck at home. Do we really need more largesse?
And could he have been better targeted? Stimulation controls are lifesavers for poor households and will be spent on goods and services. But the tax multiplier is likely to be low when a worker earning $ 70,000 a year uses his check to invest in crypto-currencies. Retirees, who have seen no reduction in their income, are also unlikely to spend exceptional checks.
In contrast, the United States needs to spend on bridges, broadband and charging stations, on improving the capacities of its population and even on upgrading the technology supporting the state’s unemployment systems. By increasing the potential growth of the economy and redirecting it towards the future, this spending could pay off. Unfortunately, this is likely to be the most controversial, as Congress is now aiming to increase income to pay for the investment.
Why only now? In the early days of Covid-19, it was necessary to act quickly to stop serious damage to the economy, given the unknown scale of the crisis. But in subsequent spending packages, politicians arguably didn’t want the populist goodies they were targeting in their constituencies to be evaluated in the disappointing light of the need to pay for them.
The new tax warning from Congress comes after a spending riot. Unfortunately, the reluctance so far to be financially responsible could limit even essential investments. And how often we are struggling with “once in a century” crises suggests that the cost to future generations of reducing their fiscal space could be substantial. Inflation is not the only risk in recent US fiscal behavior.