1. Are you not repeating the mistakes you made in 2008 of counseling insufficient fiscal stimulus because of misguided worries about inflation and the bond market?
I’m not repeating a mistake, because that wasn’t my view in 2008. Then, my assessment was that all the risks were on the side of doing too little fiscal stimulus relative to what was under consideration. Indeed, a rule I outlined for our response to the Great Recession was that “it is better to err on the side of doing too much rather than too little.” As former president Barack Obama’s recent memoir makes clear, the constraints that led to an $800 billion package rather than the larger one that I and others on the economic team preferred were political rather than economic. This point was reinforced by President Biden’s description Friday of his effort to get votes for the program. In 2009, I believed along with everyone else in the administration that in the president’s initial fiscal program it was essential to combine measures to promote demand, provide relief and make fundamental public investments as for example in renewable energy. I believe the same thing today, which is why I would be an enthusiastic supporter of a package of the size the Biden administration has proposed — and even larger — if it focused on build-back-better-style investments.
2. You have for years been alarmed about secular stagnation and with former Council of Economic Adviser chairman Jason Furman have advocated a new expansionary approach to fiscal policy. Isn’t your worry about economic overheating inconsistent with this? Isn’t it obvious that, as in the Great Recession, the risks of doing too little are greater than the risks of doing too much?
I remain concerned, as a medium-term worry, with secular stagnation, believe that fiscal policy will need to be much more active in the years ahead, and certainly share the administration’s view that policy should err very much on the side of expansion at a moment like this. But these kinds of qualitative considerations do not provide a basis for judging whether $900 billion in short-term stimulus should be followed immediately by a $1 trillion, $1.9 trillion or $5 trillion measure, prior to an ultimate multitrillion-dollar public investment measure.
The issue policymakers have to wrestle with is quantitative. In my piece, I suggested that a 13 percent of GDP total stimulus (adding the $900 billion and the $1.9 trillion) was very large, especially in an economy with extraordinarily loose financial conditions, reasonably rapid growth forecasts, still unmet public spending needs and a very big overhang of private saving. Budget deficits in 2021 on the proposed plans will quickly be approaching the record World War II levels as a share of the economy.
As the debate over stimulus plays out, it will be important to consider analyses of the proposed level of stimulus that can be delivered without setting off inflationary pressures over the next few years — especially if major new building-back-better investments are contemplated. I agree wholeheartedly with CEA member Jared Bernstein that balancing risks associated with insufficient and excessive stimulus is essential, and that it is right, given the lessons learned from the political choices made in 2008, to err this time on the side of doing too much. But 13 percent of GDP with public investment to follow needs to be justified with more than qualitative argument. Given that for example the International Monetary Fund forecasts 5.1 percent GDP growth for the United States in 2021 the proposed fiscal program seems extremely generous, but perhaps it can be justified in the debates that are ahead.
3. Why so much concern about inflation? It’s below target and has not been a problem for more than a generation. In the new economy, the Phillips curve — the relationship between inflation and unemployment — is very flat, and so increased demand leads to little if any inflation. Moreover, if inflation happens, the Fed can certainly control it by raising interest rates.
Perhaps, and this is why I was careful to speak of inflation risks rather than to confidently predict that inflation will happen. Yes, inflation has not been a major problem for a long time. I am 66 years old and was just starting my career the last time inflation was our principle economic problem. And certainly, there have been bogus warnings about inflation in the interim — most famously, the ones I and others dismissed at the time from conservative economists in the aftermath of the 2008 crash.
But ruling out risk scenarios because they have not been seen for a long time can be dangerous. Economists believed for a long time that the liquidity trap with zero interest rates was a historical curiosity. Yet it has defined the industrialized world for more than a decade.
We have no experience with fiscal stimulus like that under consideration and the impact on inflation expectations. The acceleration of inflation during the Vietnam War that was a precursor to the stagflation of the 1970s involved excessive fiscal stimulus of perhaps 1 percent of GDP annually. While they are still at nonthreatening levels, it is noteworthy that market inflation expectation measures have increased by more in the last 90 days than during any comparable period in this century, except for moments when inflation expectations were in the basement, as in 2008 or the early days of this pandemic.
Can and will the Fed control the situation effectively if inflation starts to rise? History is not encouraging. Every past significant inflation acceleration has been quickly followed by recession. Tamping down inflation will require allowing unemployment to rise, and engineering a soft landing is difficult: Unemployment has never risen by half a percentage point without then rising by almost two points, or more. Perhaps policymakers are better equipped to avert a downturn today than they have been in the past, but this kind of reassurance was confidently provided before the 2008 crash. The flatness of the Phillips curve is a double-edged sword: It implies that if inflation does arise, policymakers will have to accept substantial increases in unemployment before it starts to fall. And given the Fed’s guidance about keeping rates low, the economy’s high degree of leverage, and pressures on the dollar, I worry that containing an inflationary outbreak without triggering a recession may be even more difficult now than in the past.
4. This is a bottom-up program of relief for those who need help, not a top-down macro-stimulus program. How can you question doing whatever is necessary to help suffering people during a pandemic?
I am all for doing everything necessary to help the direct and indirect victims of the pandemic. But I do not think the case has been made that this requires the proposed level of total stimulus. Estimates by Harvard economics professor Raj Chetty and his colleagues suggest that consumer spending by low-income consumers is up more than 13 percent from January 2020 to January 2021, before any new stimulus. Researchers working with data from the JPMorgan Chase Institute find household cash balances have risen across the income distribution during the pandemic. At the proposed level of unemployment benefits, more than half of laid-off workers will see their incomes rise. Proposed expenditure levels for school support exceed $2,000 per student. I do not see the case on covid relief or anti-poverty grounds for providing either my children or my mother with a $2,000 refundable tax credit.
5. So what should the legislative package look like?
I have a lot of respect for the economic team Biden has assembled, and I know firsthand the difficult choices his officials are being forced to weigh in a critical moment in our history. There are no easy answers here. In my view, there is nothing wrong with targeting $1.9 trillion, and I could support a much larger figure in total stimulus. But a substantial part of the program should be directed at promoting sustainable and inclusive economic growth for the remainder of the decade and beyond, not simply supporting incomes this year and next. An approach of this kind, spending out more slowly, will reduce possible inflation pressures and also increase the economy’s capacity. We will be borrowing to finance sound investments rather than consumption. As Biden has emphasized, it will enable us to build back better.