During the pandemic, the federal government has put forward close to $3.8 trillion, or roughly 18% of gross domestic product, to offset the adverse economic impact of the public health crisis. The Biden administration has asked for another $1.9 trillion in fiscal aid and stimulus, on the back of the $908 billion that was put forward during the closing days of the Trump administration.
Understandably, this spending has prompted a question: Why is another nearly $2 trillion needed, right after nearly $1 trillion was allocated to address the lingering economic effects of the pandemic? The answer is in the difference between fiscal aid and stimulus, and the lessons learned from the policy response to the 2008 financial crisis.
We define the difference between fiscal aid and stimulus in the following way:
- Fiscal aid should be understood as emergency aid essential for the health and safety of the public; unemployment aid needed because of government lockdowns and changing consumer behavior linked to avoiding COVID-19; and direct aid to firms hurt by the pandemic.
- Fiscal stimulus, in contrast, is made up of funds allocated by the government to fill in deficient demand, prop up a faltering industry or promote technological advances.
So far, government funds have gone almost exclusively to fiscal aid, with roughly $2.7 trillion available for COVID-19 purposes, of which the government had spent $1.69 trillion as of Nov. 30. The bulk of that spending, or 86%, has gone to Small Business Administration loans, unemployment compensation, direct coronavirus payments to households, and to a Health and Human Services emergency fund.
There are, of course, some smaller items among the spending bills that seem to be procedural rather than directly related to COVID-19. But the House and Senate and the administration should be applauded for their quick response to the health crisis. This spending is aid for families in need—plain and simple.
Do we need a fiscal stimulus?
It is clear that with the national rollout of vaccines in its nascent phase, the federal government will soon pivot from fiscal aid to stimulus. We need to close a large output gap and begin the long and hard work of moving the economy back to full employment.
The Congressional Budget Office estimates that the economy at its lowest point last year was dealt a $2.1 trillion blow by the coronavirus, measured as the gap between actual and potential gross domestic product. That output gap has since recovered somewhat, with the gap in actual versus potential output narrowing to $633 billion by the third quarter of 2020—the latest available data.
There will be those who argue that the economy will snap back once the vaccine is widely distributed. Why do we need to spend trillions of dollars to eliminate a $633 billion output deficit?
The response to the Great Recession
We can use the recovery from the 2008-09 Great Recession as a template for policy, and this implies that the case for a robust combination of fiscal aid and stimulus makes sense here.
The financial crisis was triggered by the largest financial shock and severe downturn since the Great Depression. In response, Congress passed the American Recovery and Reinvestment Act of 2009, which amounted to an $831 billion fiscal package. But that was then followed by a backlash of such proportions that within three years the federal government adopted austerity policies that curtailed the recovery.
Our analysis of CBO estimates shows that an output gap emerged in the first quarter of 2008 during the Great Recession and grew deeper than $900 billion (in 2009 dollars) by the end of 2009. It then took nine years—until the end of 2017—to fully close that gap. The economist community holds that the extraordinarily long recovery period was because the $831 billion fiscal stimulus was too small and too late.
The economy, and more importantly, the public, were shaken by the financial crisis in 2008 and the coronavirus in 2020. The manufacturing sector was hollowed out in the Great Recession, and now service sector workers are in fear of losing their usefulness. During recessions, precautionary savings increase along with perceptions of employment fragility, which mean sustained decreases in demand and a potential deflationary spiral of foregone spending and investment.
According to an analysis—among others—by Richard Kogan and Paul van de Water at the Center on Budget and Policy Priorities, “By passing legislation that does too little, or pivoting to austerity too soon would run up less debt now but leave the economy weaker for an extended period of time.”
Yes, in 2008-09 the government saved the domestic automobile industry and the global financial system. But we would contend that the stimulus was not only given short shrift by politics and belief, but was also short-sighted over what was needed.
The takeaway
What was true in 1932 and 2008 is true now. When one faces such an adverse shock, the policy path requires the effective combination of fiscal and monetary policy, large spending programs and zero interest rates. Policymakers who are willing to overwhelm the problem and then stick to it are likely to see a faster recovery.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
