As negotiations over the next COVID-19 stimulus package flounder, 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 weak recovery, creating unnecessary hardship for households and businesses,” Powell warned in a recent speech. “The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods.”
Powell’s concern for the economic recovery, especially the hardships a second downturn would create for the most vulnerable among us, is commendable. But his macroeconomic advice is not. Fiscal stimulus has been out of favor with serious economists for decades, for very good reasons. Although well-motivated, Chairman Powell is calling for a return to the dark ages of macroeconomic policy.
In theory, fiscal policy — that is, spending by Congress designed to give the economy a shot in the arm — can achieve desirable macroeconomic goals, such as lowering unemployment. In practice, however, it rarely works. Effective fiscal policy, as economists say, should be ‘timely, targeted, and temporary.’ Unfortunately, we have no reason to expect any of these conditions to hold, given the dysfunction in both Congress and the White House. Economic indicators suggest businesses and households have weathered lockdowns, and GDP growth has picked up. The timeline of negotiations means that assistance would be delivered early next year, past the point of timeliness. Electoral incentives strongly cut against targeting the package to those who need help most: Why not shower benefits on all constituents instead? Finally, as Milton Friedman famously noted, “There’s nothing so permanent as a temporary government program.”
There are two additional problems with fiscal stimulus. First, it usually reshuffles resources rather than putting idle ones to work. As Thomas Hogan, a researcher at the American Institute for Economic Research and former chief economist for the Senate Banking Committee, writes, “Targeted fiscal policies benefit particular groups of citizens, such as the relief programs for out-of-work Americans. But such policies require Congress to decide who receives funds and who does not, which is less efficient than distributing funds through monetary policy and the financial system.” Hogan concludes that “Fiscal policy is not effective at influencing aggregate demand. It is not an effective complement to monetary policy by the Fed.”
Second, fiscal expansion makes our dire deficit situation even worse. The CBO projects a record $3.3 trillion deficit for 2020. Ineffective policy is bad enough. But ineffective and expensive policy is simply intolerable.
That central bankers are leading the charge for additional fiscal policy is particularly concerning. The superiority of monetary policy — changing the money supply to achieve macroeconomic goals — over fiscal policy was a hard-won lesson of the late 20th century. Some commenters think that monetary policy cannot be effective in our current environment of ultra-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 help implement monetary policy, but they are not the main transmission mechanism. As long as the Fed can create new money and purchase additional assets, it can give the economy a boost…so long as the public believes the Fed’s commitment to accommodative policy is credible, that is. If the public thinks the Fed won’t follow through, markets won’t rebound.
In fact, the Fed recently tried to convince markets it was getting serious about helping the economy. But so far, the results are negligible. Given the Fed is having a hard time building credibility, the last thing monetary policymakers, let alone the Fed chairman, should do is request more fiscal support. Such calls amount to a white flag of surrender from the central bank. It’s an implicit admission that monetary policy has reached its limit, and thus undermines the Fed’s recent attempts to persuade markets it means business. The monetary insufficiency argument was wrong in 2007-8, and it’s wrong now. But the Fed’s recent actions help propagate the misconception.
Fed officials should stop haranguing Congress and do their job: supporting the economy with monetary policy conducive to full employment and stable prices. Every time monetary policymakers call for additional fiscal stimulus, they signal to markets that they are incapable of providing the necessary economic support. Provided the Fed credibly commits to bolstering the economy, there’s no need for more fiscal misadventures.