Four Reasons for Phase Four

Lawmakers are already discussing the possibility of a “Phase Four” for coronavirus relief not even two weeks off the heels of passing an historic $2 trillion stimulus package. House Speaker Nancy Pelosi and Senate Minority Leader Chuck Schumer have voiced support for continuing economic relief despite pulling back on ambitious goals for vast infrastructure spending. Meanwhile, President Donald Trump is picking up support for an infrastructure bill where the Democrats left off. The question is, why not both? Yes, and yes, and how about more, …and everything in between? I’m talking Oprah-level “You get a car! You get a car! And YOU get a car!” kind of policy.

If we can learn anything from the Great Recession, it’s that putting the breaks on stimulus spending too early is perhaps the exact opposite of what we should be doing right now. Not only is “Phase Four” stimulus spending a necessity, but it should also be comprehensive and ambitious. Here are four reasons why:

1. Unemployment is hitting an all-time high, it’s likely to get worse, and the subsequent recovery will take longer than we think.

On March 26, the U.S. Department of Labor reported that on the week ending on March 21, 2020, nearly 3.3 million people filed for unemployment insurance.¹ This shattered the previous record for unemployment claims filed in a single week, set on March 28, 2009, by a factor of 5. The following week, ending on March 28, 2020, 6.6 million more people filed for unemployment insurance, swiftly dwarfing the previous week’s record-setting numbers.² As of the writing of this piece, over 10 million Americans have filed for unemployment insurance over the course of only two weeks, a number that eclipses the previous records set in the early 1980s and late 2000s both in sheer numbers and in proportion to the labor force at the time.

Source: NPR¹

The Bureau of Labor Statistics (BLS) announced that the unemployment rate for the month of March 2020 rose to 4.4%.³ This is certainly underreporting the true unemployment rate given that the BLS survey used to determine the unemployment rate is conducted early in the month and the measures taken in response to the coronavirus pandemic began to make tangible economic impacts in the latter half of the month. A New York Times Upshot column estimates the true unemployment rate to be around 13%, higher than at any point since the Great Depression, and they predict it will keep rising as the forced economic shutdown continues.⁴

Regardless of how high the unemployment rate is, one thing is clear as borne-out by data: it takes a long time for unemployment to fall to its pre-contraction low. See the following graphic provided by the Federal Reserve Bank of St. Louis:

Source: Federal Reserve Bank of St. Louis⁵

We observe that once a recession ends — marked by a full quarter of falling unemployment and rising GDP — it takes anywhere from one to six or more years for unemployment to reach what economists would describe as full employment, the state in which all who are willing and able to work are employed.

2. Liquidity Now!

No one knows for certain what the future will hold with the possible economic contraction, but what we do know is that the prospect of a speedy “V-shaped recovery” dwindles every day we remain shut down. Similar to how a person’s body in cardiac arrest is damaged each minute it is starved of oxygen, the economy is further damaged every day money doesn’t change hands. And considering the stranglehold this pandemic has had on the nation’s health and economy already, restarting the economy in the fashion espoused by President Trump and his allies would likely make the pandemic explode to disastrous proportions, ravaging the U.S. population and bringing the economy along with it. A working paper by Northwestern economist Martin Eichenbaum and others demonstrates that these social distancing shutdown measures might in fact yield a better economic outcome than “letting it rip,” and that “better” outcome is still a decline in GDP to the order of nearly 20%.⁶

This means that the closest thing to a magic bullet we have right now is providing liquidity, which basically means giving cash to people and businesses whose cash flows — in the form of income and spending — have ceased due to the shutdown.

A common talking point among pundits who have a particularly rosy take on this downturn is that the fundamentals of our economy were good going into this market crash. That’s true, but fundamentals are only good so long as businesses and people don’t become insolvent and earnings don’t plummet. Consumer spending is already down across all categories besides groceries and electronics⁷:

Businesses need to pay their debts. Individuals need to pay for their rent and mortgages. Once debt-holders begin defaulting due to a lack of cash-on-hand, we’ll start to see a crumbling of the financial system akin to what happened in 2007, only this time it will happen in the midst of already record-breaking unemployment and a global pandemic.

3. Crowding out is of little concern.

A common critique of government deficit spending is that it discourages private investment through a phenomenon known as crowding out. The logic is that when the government borrows money by issuing bonds, it in effect takes up money that could have otherwise been spent on private projects. This means there’s a smaller supply of loanable funds available, and the interest rate — the cost of borrowing money — rises. The implication of this, and the one deployed by critics of deficit spending, is that government deficit spending doesn’t increase economic activity, it simply moves the same amount of money around.

This logic seems straightforward enough on its face, but it’s only half the picture. Interest rate-setting is influenced primarily by the Federal Reserve, which adjusts the money supply to affect interest rates. When the money supply is increased, more money inevitably gets put into less liquid assets, such as bonds. The increased demand for bonds drives their prices up while making their yields fall, forcing interest rates down. To think about it another way, whatever supply of loanable funds the government sucks up in its deficit spending, the Federal Reserve can simply inject that money back into the economy by printing money. With these countervailing mechanisms at play, crowding out ceases to become an issue. It’s the yin and yang that is fiscal and monetary policy.

The intuition of this is codified in the old Keynesian model known as IS-LM, which stands for investment-savings (IS) and liquidity preference-money supply (LM). For the wonks out there, Paul Krugman has a fantastic article that explains the theory of it in great detail.⁸

The obvious concern with this policy prescription is rampant inflation. For those who understand the mechanism of IS-LM, or those who read Krugman’s article, you’ll see that with our zero-interest-rate environment and immediate liquidity issues, helicopter-dropping money right now won’t lead to a consumer spending spree as much as it will afford people the chance to set money aside to save for immediate or near-term expenses. Even though the money supply is larger, that doesn’t mean it’s all moving.

4. Many forms of government spending are likely to pay for themselves in the long run.

It’s common for critics of government spending to accuse politicians of shifting the burden of debt onto the next generation. The truth is that the degree to which this happens is highly dependent on the type of government spending that takes place. In fact, many government programs, when implemented properly, can generate a positive return on investment and actually pay for themselves long term.

When we mean a public program “pays for itself,” what we’re really saying is that the increase to GDP is larger than the increase to our national debt as a result of the program. Deficit spending is sustainable if we keep our debt-to-GDP ratio stable, and a program that pays for itself can — on paper — actually lower it.

We refer to the effect of government spending impacting GDP in the form of a multiplier: a dollar spent by the government increases GDP by X amount of dollars. Certain public expenditures, such as infrastructure projects, have a multiplier of 1.57, meaning that $1 of government spending yields a $1.57 increase in GDP. Other policies, such as tax cuts for the wealthy, have a multiplier of 0.32, meaning every $1 spent on tax cuts yields a $0.32 increase in GDP, so that’s an inefficient use of government spending that shifts the debt burden to the next generation. The paper “How the Great Recession Was Brought to an End,” by Alan S. Blinder and Mark Zandi shows some examples of public spending that are great “bangs for the buck”: infrastructure, food stamps, and payroll tax holidays to name a few.⁹

What this means for “Phase Four.”

On the precipice of possibly the worst economic collapse since the Great Depression, the most powerful thing a government can do is restore stability. In this political and economic moment, that means providing liquidity for those who need to pay off debt, giving people money to spend so demand doesn’t collapse, and setting up a system that will allow businesses to restart as quickly as possible once the necessary public health shutdown measures have been lifted. A one-off $1,200 payment that may come in a few weeks or a few months is a start, but it’s not going to cover the mounting expenses that risk triggering evictions, defaults, and bankruptcies for countless individuals. We need to adopt the mindset of George Constanza’s “Human Fund” — money for people.

In the spirit of not letting a crisis go to waste, it would behoove Congress to use this opportunity to enact sweeping infrastructure spending that is ready to roll once we begin to control the spread of this virus. Infrastructure that extends beyond the typical roads and bridges: green energy, medical supplies, disaster stockpiles, etc. Learning from the mishandling of this crisis means we can face the next one with fewer disastrous consequences. It’s prophylactic governing.

And while $2 trillion is the largest stimulus bill in nominal terms, it’s not the largest as a proportion of our GDP. We’ve got some wiggle room here.

Trump loves to talk in superlatives. Frame it in the right way, and you’ll see him out there touting the “biggest, most beautiful stimulus we’ve ever seen.” I don’t want to see that for his political capital. I want to see that for the sake of our economy.