President BidenJoe Biden Former representative Rohrabacher says he took part in the Jan. 6 march to the Capitol but did not storm the buildingAFR’s $ 1.9 trillion COVID relief program has sparked heated debate among economists. Package Reviews argue that it does not target the most needy recipients; whereas it is much more important than necessary to revive the economy towards full employment; and that it will revive inflation as a result and increase the federal debt dramatically. Promoters underline the very unequal nature of the nation’s recovery; that after years of moderate inflation, there is no indication that the expansion will produce anything other than a short-lived price spike; and that in light of the enormous challenges posed by the current pandemic, going big is less risky than going small.
While all of these arguments have merit, another benefit of a substantial fiscal stimulus has been largely overlooked: that it will allow interest rates to return to higher levels and thus help restore balance to our economy. and our financial sector. For years after the 2008 financial crisis, fiscal prudence forced the Federal Reserve to support the economy, making monetary policy “the only game in town.” And with other sources of spending – consumer purchases, business investment, foreign sales – also relatively low, the level of real (inflation-adjusted) interest rates needed to balance the economy, often called the natural interest rate, or r *, has declined. According to the estimates of the Federal Reserve Bank of New York, r * fell from around 2.5% in the years before the financial crisis to around 1% before the onset of the pandemic. And the Federal Reserve, with its 2% inflation target and full employment mandate, had to cut its key rate at the same time as r *.
When lower interest rates encourage companies to borrow more in order to invest in equipment and other productive assets, this not only stimulates spending and jobs in the present, but lays the foundation for growth and future prosperity. But falling interest rates probably don’t increase corporate capital spending like they used to. Interest rates are already well below target rates of return for projects by management; and with in recent years, companies have made more profits than they spent on investments, they have amassed lots of money which reduces their dependence on borrowing.
As business investment is less sensitive to interest rates, it falls to other monetary transmission channels to do the heavy lifting of economic stimulus, and these have their own problems. The revival of housing investment, if it is prolonged too long, risks replaying the subprime crisis. Encouraging other forms of household spending only shifts consumption from the future to the present, a dubious benefit for the millions of Americans already on the verge of missing their retirement goals. Stimulating stocks and other asset prices carries the potential for excessive valuations and bubbles; this channel can also exacerbate inequalitiesbecause it will benefit the richest portfolios more than those of the poorest households. Finally, prolonged low interest rates hurt savers and hurt the balance sheets of insurance and pension funds, a particularly important concern for many states and municipalities.
Absent substantial further fiscal stimulus, a resurgence of the pandemic or another adverse shock that has held back the economic recovery could mean years of consistently low interest rates. Conversely, a robust recovery fueled by fiscal spending would allow the Fed to reduce its asset purchases more quickly, raise interest rates from their lows and return them to more normal levels.
Admittedly, such a tightening of financial conditions carries its own risks, especially if it is caused by a sharp and persistent rise in inflation: it could in principle trigger a disruptive crash in asset prices and bankruptcies of companies that have heavily borrowed during the year. But a sustained inflationary surge does not seem the most likely scenario, and businesses and markets should be able to handle higher rates driven by a stronger economy. Indeed, even as bond yields rose against a backdrop of expectations of the stimulus plan and higher inflation stock prices rose again and high yield corporate bond spreads continued their decline.
A major fiscal stimulus plan would of course increase the federal debt. But current low interest rates allow the government to finance its spending very cheaply, and as the world’s largest reserve asset issuer, it is doubtful that the federal government is near its borrowing limit. So it makes all the more sense to move from our previous reliance on monetary stimulus and rising private sector debt to a more balanced approach involving more fiscal stimulus and public debt.
Steven Kamin is a resident researcher at the American Enterprise Institute (AEI), where he studies international macroeconomic and financial issues. Prior to joining AEI, Dr Kamin was Director of the Federal Reserve’s International Finance Division.