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Insurance, Not Stimulus

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Insurance, Not Stimulus

March 27, 2020

The Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed by the House on Friday. Even though for many American households and businesses relief couldn't come soon enough, politicians and economists took their time debating the bill's structure. It has widely been referred to as a stimulus bill by the media, but this is a misnomer—it is not stimulus, it is insurance. The difference is not just over semantics. Understanding the purpose of the bill can help lawmakers craft the right policy and overcome political hurdles and will help everyone judge its success. 

A fiscal stimulus aims at increasing demand that has fallen for an economic reason, like what happened in the 2008 financial crisis. The goal of fiscal stimulus is to get money into consumers’ hands so they can spend more and generate more demand for goods and services. But economists are divided on how well fiscal stimulus works. Evidence suggests that its success depends on the nature of the shock, on where the money is spent, and on the state of monetary policy, all of which leaves lots of room for disagreement. Some economists think spending the money anywhere—paying people to dig holes and fill them up—works. Others think you should just give people checks. Our national experience with trying to manipulate demand by means of these tactics suggests that they often don’t work and are not worth the cost. And today doing these things might even be harmful since, in order to stop the virus, we need to slow economy activity. 

We don’t need a stimulus—what we need is for the government to step up as an insurer. Insurance is a risk reduction strategy. It involves someone paying you upon the occurrence of an event. It allows an insured party to feel protected from shocks while benefiting from the upside of growth. This shock was large and unforeseen. Most households and businesses never imagined months of a shut-down economy, and don’t have the cash to pay their monthly bills. It is easy to say now that firms should have had months of cash on hand without taking on any debt, but if they did these things in good times we’d complain that they aren’t sufficiently investing in growth. Keeping an amount of cash on hand that would allow them to self-insure against a shock caused by a virus is inefficient and would lead to lower growth. Ideally, firms could buy insurance against this risk, but a large competitive market for such insurance does not exist. The optimal strategy instead is for individuals to self-insure for small disturbances but to rely on government to insure against extremely rare, catastrophic events. 

Firms and households need the government to protect them from extreme hardship. This is the purpose of government, which is in the best position to manage risk because it can diversify across people and generations. Some risks are otherwise uninsurable without the presence of government. Because extreme events like this one are at least possible, its role makes participation in the economy less risky. Of course, the downside of insurance is that it creates a moral hazard; that is, people taking on more risk because they don't need to worry about the downside. But moral hazard should not be a concern at the moment because a shock this large is unpredictable and thankfully infrequent. 

The distinction between insurance and stimulus matters. First it helps us understand what ideal legislation to address the shock should include. Concerns about unemployment benefits discouraging work only make sense if the goal is stimulus, not insurance against a forced economic shutdown. It also helps us to identify which businesses need help. Small- and medium-sized businesses need life support, not increased demand, which means they need access to capital to stay in business and reopen when restrictions are lifted. Bigger firms need capital too—this is not 2008 when their flawed risk assessment was the cause of the shock. But at least in theory bigger firms can secure capital in financial markets rather than directly from the government. 

The fact that what is needed is insurance can also explain the Fed’s actions. An interest rate cut is intended to increase economic activity, but the Fed’s new policies aren’t meant to do this. Their interference in mortgage-backed securities and in the corporate and municipal bond markets, and their provision of swap lines of credit are all about providing liquidity so that markets won’t seize from the shock. These steps are designed to ensure that firms and local governments can continue to function. 

The right name also changes the politics. Democrats tend to believe demand-boosting stimulus works, while Republicans are more skeptical. But most people can agree that the government is well-positioned to provide insurance against large, unpredictable shocks. 

Allison Schrager is a senior fellow at the Manhattan Institute. Follow her on Twitter here.

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