As the economic recovery falters, is more stimulus the answer?

According to some estimates, the combined fiscal and monetary stimulus injected into the economy in the second quarter (around $5 trillion) may have exceeded nominal GDP (initially estimates put the figure at $4.85 trillion). Despite the record stimulus, hopes for a rapid U.S. economic recovery have been dashed, and another dip in economic activity appears increasingly likely. 

The 2020 recession is unique in the sense that it was triggered by a health crisis. Moreover, there is a considerable degree of uncertainty related to the availability and efficacy of treatments and potential vaccines that will ultimately determine the speed and nature of the economic recovery. The magnitude of the economic contraction also poses a challenge. The pace of economic decline thus far suggests that the current recession will be deeper than the Great Recession. (Around 54 million people applied for jobless claims between March and July.)

Typically, both monetary and fiscal measures are utilized to address economic shocks. But monetary authorities have had to bear much of the burden of propping up the American financial system and the broader economy ever since the housing bubble burst in 2007. During the past dozen years or so, fiscal policy has for the most part played second fiddle to monetary policy. A toxic political environment in Washington D.C., characterized by extreme political polarization and dysfunction, has made it difficult for fiscal authorities to pursue effective government spending and tax policies. Monetary policy, under the purview of technocrats who staff the Federal Reserve System, is generally assumed to be independent of political pressures and immune from petty electoral considerations. Furthermore, the central bank’s ability to rapidly adjust the flow of liquidity and turn on/off the monetary spigot implies that monetary policy measures are fast-acting and not typically subject to the inherent lags that hinder fiscal policy actions. 

As the severity of the threat posed by the pandemic became apparent in March, swift and forceful actions by monetary authorities prevented the economic crisis from morphing into a financial crisis. Surprisingly, fiscal authorities stepped up to the plate when they came together early on to pass the massive CARES Act. Despite some implementation delays, and, in spite of some examples of corrupt practices, the huge fiscal stimulus program has been well-received and has proven to be quite effective. 

The economic reopening in May and June initially provided a glimmer of hope as the economy appeared to be coming back to life from the self-induced coma. However, the lack of clear, consistent and science-based guidance at the federal level, and a rush to reopen in several Sunbelt states, has led to a resurgence of COVID-19 infections, and the U.S. increasingly appears to be an outlier among advanced countries. The rise in coronavirus-related hospitalizations and deaths in Western and Southern states has caused growing public anxiety and has stalled the recovery.

As fears of a double-dip or W-shaped recession take hold, there is growing clamor for fresh monetary and fiscal interventions. The Federal Reserve exhausted its traditional monetary policy toolkit early (policy rates reached the zero-lower bound in March) and, now, there are fears that some of its unconventional measures may be distorting financial markets. High stock prices are at least partially driven by the surge in central bank liquidity. Bond prices are near record-highs, and there are growing concerns that excessive monetary interventions might be propping up zombie companies as credit conditions have drastically eased. Additional monetary actions may have limited impact on the real economy and may even create further financial distortions. The case for fresh fiscal stimulus, however, is much clearer.

First and foremost, significant spending on health care and medical research is vital — a true recovery is unlikely until the health crisis is resolved. Second, boosting support for state and local authorities that are facing severe budgetary shortfalls will help mitigate a looming economic threat (according to some estimates, states may face a cumulative $550 billion budgetary shortfall between 2020 and 2022). Third, empirical research suggests that direct cash transfers to low-income households (which typically exhibit a high marginal propensity to consume) can be quite effective. Indeed, the stimulus checks distributed under the CARES Act provided a much needed fillip to consumer spending. 

Longer term, the U.S. needs enhanced automatic stabilizer programs (such as an improved unemployment insurance program that provides sufficient relief and yet incentivizes search for formal employment) aimed at automatically dampening the fluctuations in the real economy. Automatic stabilizers reduce tax burdens and increase transfer during recessionary periods without a congressional policy lag. Adopting measures to strengthen automatic stabilizer programs will limit the inevitably destructive political drama and the unnecessary delay in shoring up the American economy now and well into the future.  

While medical doctors are encouraged to pledge to abide by the dictum “first, do no harm,” economists and policymakers typically have no such constraints placed on them. The pandemic poses a particularly severe test for economic policymakers since the potential for mistakes are abundant and the long-term consequences of policy errors might turn out to be quite significant. 

Vivekanand Jayakumar is an associate professor of economics at the University of Tampa. Brian Kench is a professor of economics and dean of the Pompea College of Business at the University of New Haven.