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The Market Lover’s Argument for Fiscal Policy

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The Market Lover’s Argument for Fiscal Policy

March 19, 2020

Economists like to say everyone is a Keynesian in a foxhole. But this will be no normal recession. It illustrates the purpose of fiscal policy. Actually, the evidence is mixed that fiscal policy is always effective at boosting demand. But that does not mean there is no role for fiscal expansion. The scope of fiscal policy is not demand management; it is about risk management, which means preserving the arsenal of fiscal and monetary expansion for when it is needed and can be the most powerful.

A big purpose of the government is to reduce risk. There are costs to this, in terms of the dollar value of bailing people out when risk goes wrong, as well as the moral hazard created when government backstops encourage people to take more risk. But it is still a necessary function. Sometimes individuals or businesses would like to reduce their risk, but they cannot, either because the insurance market does not exist, insurance is too expensive because the market is not competitive, or the costs of hedging are just too high. Or, as in the case of the coronavirus, there is large tail risk, which is impossible for most people to foresee and, even if they did, it is not realistic for households or businesses to adequately insure for it. Moral hazard is not a big worry in this case because (we hope) this is a once-in-a-generation event. Relief now is what the government is built for. In addition to stopping the spread of the virus through public health initiatives that will effectively shut the economy down for weeks, or more likely months, government can relieve hardship while the economy is on ice and increase the odds of a speedy recovery. These are efficient roles for the government to play because it is in a better position to diversify. Because government can pool risk across its citizens and borrow cheaply, it can take money from the future to alleviate pain today.  

But that does not justify reckless spending. It is true that interest rates are low now, but the debt we incur will be around for decades, and rates may well go up before the debt is repaid. If public relief funds are spent poorly and there is a long, prolonged recession, America will find itself paying for public debt when it has little fiscal capacity to do so. It is still wise to spend money where it will be most effective. Unlike previous stimulus, the goal is not boosting demand. The goal is offering insurance to firms and households, so they can survive and recover quickly when the virus wanes.

For example, many households face uncertainty about how long it will be before they see another paycheck and do not have the savings to survive months of reduced or zero income. Yet they still need to eat, pay rent or mortgages, and pay their existing debts. This is why they need income support, either through direct transfers or expanding the safety net. Sending everyone (or most Americans) $1000 may offer some immediate relief to households, but if the shutdown goes on for months, the cost of sending every American a check each month will become too expensive and face diminished returns.

The government also needs to expand the safety net to better target workers who are directly impacted. The goal is not propping up demand. The goal is keeping households from destitution and keeping them optimistic that they will soon be back to work. Policies that cut the employer side of the payroll tax and provide assistance to firms paying sick leave and health insurance will help to this end. However, many firms cannot continue to pay their workers while they are shut down. Ideally, workers can be furloughed or paid for fewer hours rather than laid off entirely. Even furloughed workers will need income support during this time. The terms of unemployment insurance should be temporarily relaxed so they don’t require the beneficiary to be looking for work. The current furlough and part-time requirements can also be relaxed so unemployment benefits should also be paid to workers who are still attached to their employer but are unpaid or are being paid less because their hours have been cut. Unemployment benefits could also be extended to gig workers who aren’t currently working or working fewer hours.

Many businesses, especially retail and restaurants, operate on very thin margins and cannot cover their debts or rent without revenue. First, businesses should be allowed to delay paying their taxes for the next two quarters. They also need access to interest-free or very low interest loans to avoid bankruptcy. The key is making sure they have enough capital to stay in business. This is true for both large firms and small- and medium-sized businesses. Many of the Fed’s actions aim to do this, by making it easier for banks to extend credit to large firms and working with the Small Business Administration (SBA). Getting loans should be easy. Often, seeking credit through the SBA entails time and red tape — in the current crisis, this process needs to be streamlined as much as possible. The Fed also needs to keep the corporate bond market as liquid as possible, especially the market for commercial paper, which is a critical source of short-term financing. Janet Yellen and Ben Bernanke even endorse the Fed buying investment-grade corporate debt.

Extreme times like this highlight the government’s role as the insurer of last resort. It can keep families afloat and speed up recovery when a big unforeseen, and uninsurable, event happens. This is not inconsistent with caution and keeping deficits in check when times are good. The government is fortunate. Despite running up big deficits in recent years, it still has the fiscal space to do what it needs to. Next time, it may not be so lucky.

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

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