Fiscal Stimulus Is Ineffective. The Fed Requesting It Is Even Worse.
As negotiations on the next COVID-19 stimulus package falter, Federal Reserve officials are pushing for greater fiscal support from Congress. Particularly noteworthy is Fed Chairman Jerome Powell's call for more spending. "Too little support would lead to a poor recovery and create unnecessary trouble for households and businesses," Powell warned in a recent speech. "The recovery will be stronger and faster if monetary and fiscal policy continue to work side by side to support the economy until it is clearly out of the woods."
Powell's concern about the economic recovery, particularly the difficulties a second downturn would create for the most vulnerable among us, is laudable. But his macroeconomic advice is not. Tax incentives have been unfavorable for serious economists for decades for very good reasons. Although well motivated, Chairman Powell calls for a return to the dark ages of macroeconomic politics.
In theory, fiscal policy - that is, the spending by Congress designed to boost the economy - can achieve desirable macroeconomic goals such as lowering unemployment. In practice, however, it rarely works. Effective fiscal policy should, as economists say, be “timely, targeted and temporary”. Unfortunately, given the malfunction in both Congress and the White House, we have no reason to believe that either of these conditions is met. Economic indicators suggest that businesses and households have weathered lockdowns and that GDP growth has accelerated. The timetable of the negotiations means that aid will be provided early next year beyond the timeline. Electoral incentives go heavily against targeting the package to those who need it most: why not shower the benefits for all constituents instead? Finally, as Milton Friedman famously noted, "There is nothing as permanent as a temporary government program."
There are two additional problems with fiscal incentives. First, resources are usually reshuffled instead of getting unused resources up and running. Thomas Hogan, researcher at the American Institute for Economic Research and former chief economist of the Senate Banking Committee, writes: “Targeted fiscal policies benefit certain groups of citizens, such as assistance programs for unemployed Americans. For such a policy, however, Congress must decide who will receive funding and who will not. This is less efficient than distributing funds through monetary policy and the financial system. "Hogan concludes that" fiscal policy is not effective in influencing aggregate demand. It is not an effective complement to the Fed's monetary policy. "
Second, the budget expansion is compounding our plight. The CBO is forecasting a record deficit of $ 3.3 trillion in 2020. Ineffective politics is bad enough. But ineffective and expensive policies are just unbearable.
Of particular concern is that central bankers are citing the fee for additional fiscal policy. The superiority of monetary policy - changing the amount of money to achieve macroeconomic goals - over fiscal policy was a hard-won lesson from the late 20th century. Some commentators believe that monetary policy may not be effective in our current environment of extremely low interest rates, but this argument reflects a fundamental misunderstanding of how monetary policy works. Interest rates are a target used by central banks to implement monetary policy, but they are not the main transmission mechanism. As long as the Fed can create new money and buy additional assets, it can boost the economy ... as long as the public believes the Fed's commitment to accommodative policies is credible. If the public thinks the Fed can't get through, the markets won't rebound.
In fact, the Fed recently tried to convince markets that it was getting serious about helping the economy. So far, however, the results are negligible. Given the Fed's difficulty building credibility, policy makers, let alone the Fed chair, should be the last to ask for more fiscal assistance. Such calls are a white flag of the central bank. It is an implicit admission that monetary policy has reached its limits, undermining recent attempts by the Fed to convince markets that this is business. The monetary inadequacy argument was wrong in 2007-08 and is now wrong. However, recent actions by the Fed are helping to spread the misunderstanding.
Fed officials should stop pestering Congress and do their job: support the economy with monetary policies conducive to full employment and stable prices. Every time monetary policymakers call for additional fiscal stimulus, they are signaling to markets that they are unable to provide the economic support they need. If the Fed makes a credible commitment to strengthening the economy, no further tax mishaps will be necessary.
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