US President Joe Biden, facing the great challenge of stimulating his country’s economy for the post-pandemic era, and haunted by then-president Barack Obama’s tepid stimulus in the face of the Great Recession a decade ago, has decided to err on the side of overshooting. He wants to “go big” with a $1.9 trillion spending plan.
Prominent centrists like Larry Summers and Olivier Blanchard warn that Biden’s decision may prove his undoing. Their argument is that too much stimulus will trigger an inflationary surge, resulting in an interest-rate spike that will force his administration to slam on the austerity brakes just before the midterm elections in 2022, costing his Democratic Party control of Congress – just as too little stimulus cost Obama control of Congress in the 2010 midterms.
The problem with this debate is that both supporters and critics of Biden’s stimulus plan assume that there is a dollar amount that is big enough, but not too big. Where they disagree is on what that figure is. In fact, no such figure exists: every possible stimulus size is simultaneously too little and too big.
To see why there can be no “Goldilocks” stimulus that gets the amount “just right,” it helps to engage the critics who argue that the administration’s proposal would overheat the economy and hand the Republicans the midterms. Central to their prediction is their tacit assumption that there is also a Goldilocks interest rate and a corresponding stimulus size that will deliver it.
What would render any rate of interest “just right”? First, it would achieve the right balance between available savings and productive investment. Second, it would not unleash a cascade of corporate bankruptcies, bad loans, and a fresh banking crisis. And there’s the rub: It is not at all clear that there is a single interest rate that can do both.
Following Wall Street’s near-death experience in 2008, corporations became hooked on (almost) interest-free credit and rising stock valuations that flew in the face of low profits. Total savings dwarfed investment, aggregate wages were at an all-time low, and consumer spending remained subdued. And then, suddenly, Covid-19 arrived, with the ensuing lockdowns dealing major blows on both the supply and the demand side of the economy.
The 12 years before the pandemic arrived explain why a sizeable stimulus today may not achieve what it could have achieved in 2009. A successful stimulus must bring investment closer to the level of available savings. But the moment financial markets get a whiff that this is about to happen, they will push interest rates up to a level reflecting the better balance between savings and investment. Immediately, corporations hooked on low interest rates will face ruin; so will their bankers.
In theory, this can be prevented if the stimulus simultaneously boosts incomes and consumption, so that corporations’ rising income can compensate for the rising interest rates. But, in practice, there is no time for corporations to be weaned off their dependency on low interest rates, because any stimulus takes a lot longer to stimulate incomes than it does to boost interest rates.
The combination of the liquidity trap and 12 years of corporate dependency on near-zero interest rates has, therefore, seen to it that any fiscal stimulus now, whatever its size, is bound to fail in one or both of its crucial aims: To boost investment and to prevent a chain reaction of corporate failures.
“Going big” might have worked in 2009, but in 2021 Biden must go beyond fiscal stimulus. Whatever quantity of money he pumps into the US economy, he will fail unless he does what is necessary to lift the spending power of those who have next to none: a decent minimum wage, compulsory collective bargaining, and direct unconditional payments. – Project Syndicate
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