COVID-19 (Corona Virus Disease-2019), hit the world in an unprecedented way. Almost no one was prepared for the massive toll on Economic and Health status. It is thus only fair to ask ourselves, what can public policy do in a time like this. For starters, how best can a Government employ it's tools to lessen the blow. For this I refer to an illuminating Brookings article by Jay Shambaugh (Nonresident Senior Fellow - Economic Studies)
Giving a brief-preview of what the article covers:
Q: Why aren’t the Federal Reserve’s monetary policy tools sufficient to sustain the economy? Why must we also rely on Congress to enact fiscal policy?
A: The core problem the economy faces is not a lack of liquidity, but a temporary halt of activity due to health restrictions and a fundamental question of solvency for many firms and individuals. Thus, the activities of the Federal Reserve are important, but unlikely to be sufficient.
In many economic slowdowns, the Federal Reserve is the front line of defense. In this case, it has already lowered interest rates to zero and begun sizable purchases of assets along with injections of liquidity into financial markets. These actions are important, but unlikely to shield the economy from widespread damage. First, the shutting of businesses and limits on travel will cause economic activity to contract regardless of policy. Second, as the Federal Reserve has already lowered rates to zero, it is out of conventional ammunition to stimulate the economy, leaving it to use alternate tools like asset purchases or forward guidance. The Federal Reserve typically stimulates the economy by making it easier and less expensive to borrow, encouraging firms and consumers to accelerate investment and purchasing decisions. In this case, the uncertainty about the eventual outcomes of the COVID-19 pandemic and the economic fallout may make it very difficult for firms to borrow regardless of rates (the credit risk may keep banks from lending), and more importantly, the option value of waiting to see the resolution of the pandemic will likely slow any investment or major purchase decisions.
Q: How can fiscal policy help the economy?
A: The primary goal for fiscal policy at present should be to cushion the downward shock as much as possible and set the conditions for the economy to bounce back after the restrictions on economic activity are removed. Over time, fiscal policy can be used to try to help restart the economy.
Beyond spending on the crisis itself, there are a number of important roles for fiscal policy. While discussions at present refer to stimulus, in some ways it is the wrong term currently. The economy is being shuttered to allow for social distancing and to stop the virus. First, federal fiscal policy can strengthen the safety net to make sure anyone losing a job or with limited resources can get through the next few months. The expansion of paid sick leave benefits to a wider (though still limited) set of the population could be an important economic cushion and a way to slow the spread of the virus. In addition, the government can distribute funds directly to households to ensure that families have a financial cushion and that there is adequate purchasing power in the economy as households weather social distancing and when restrictions are lifted. Fiscal policy can be used to guarantee loans and/or provide direct support to firms that are in trouble to prevent systemic problems in order to maintain their payrolls. Finally, the federal government can provide financial support to states. States have limited capacity to borrow, and when their costs go up (due to health and public safety measures) but revenues go down (due to lower tax returns), they are often forced to cut spending. Federal support can shore up state spending, especially as states are on the front lines of the public health crisis. Over time, the emphasis of fiscal policy should shift toward increasing spending and resources in the economy to restart economic activity.
Q: How big should a fiscal package be?
A: The fiscal policy package should be large enough to address immediate needs and persist over the longer-term through public-health-based and economic-condition-based triggers.
At present, fiscal policy responses are primarily aimed at cushioning the blow to households, states, and firms. That alone will likely require the largest single fiscal policy package ever (likely well in excess of a trillion dollars, but potential need is possibly much larger). One way to scope a plan appropriately would be to pass everything that is clearly needed now and allow subsequent payments (to households, states, and firms) to vary with health and economic conditions over time. Such an open-ended commitment could be massive, but if appropriate triggers for later spending are put in place, and those thresholds of economic or health distress are crossed, then it would be appropriate to have such a large package. Throughout the month of March, any potential response mentioned has seemed too small a week later. As such, it would make sense to begin with a very large package and allow for continual fiscal activity if conditions warrant. While the budgetary impact may be substantial, at present, the United States government borrows at historically low rates. Markets do not doubt U.S. government solvency, and any longer-run budget concerns should be addressed after the current crisis is past.
Q: Why does the federal government need to help states’ finances?
A: Substantial support for states from the federal government can alleviate budgetary pressures from increased spending on public health, unemployment, as well as reductions in consumption-based revenue. Such budget help would give states the resources they need to fight the pandemic and also make it less likely that states act as a brake on economic activity going forward.
States are on the front lines of the pandemic. Protecting their citizens will raise public safety and public health expenditures. Making sure states have adequate resources to fight the downturn is a crucial part of a public health response. Legislation in mid-March provided states with more funding by increasing the federal share of Medicaid spending. Certainly, more help will be needed both for acute issues (purchasing medical equipment, funding hospitals and health centers) and longer-term medical costs. An additional increase in the federal share of Medicaid as well as grants of unrestricted funds to make sure states and localities can continue to meet their obligations for health and public safety are necessary. Furthermore, the coming wave of unemployment will put pressure on state unemployment insurance trust funds, and they will almost certainly require support. At the same time, a decrease in economic activity means lower tax revenues for states. States generally cannot borrow for current operations, forcing them to either raise taxes or cut spending when a downturn worsens their budget outlook in the short term. This can have spillover impacts on the economy, limiting the potential for the economy to grow after the health restrictions are lifted.
Q: What role can safety net programs (such as UI, SNAP, WIC, etc.) play in reducing the impact of an economic downturn?
A: The safety net in the United States is one of the most important fiscal automatic stabilizers we have. As economic conditions deteriorate, spending rises on Unemployment Insurance (UI) and SNAP (formerly known as the Food Stamp Program), pushing billions of dollars into the economy. A sizable advantage of these programs is that they are well-targeted to households and regions that need the help most, and they put resources in the hands of people highly likely to spend due to liquidity constraints. In addition, because these programs already exist, they can get money to households quickly compared to creating new programs.
At the same time, the safety net can be used more effectively. UI can be challenging to access including waiting periods, administrative burdens, and search rules. All should be eased at this time. Further, UI does not replace all lost wages in order to provide an incentive to find work. In the current crisis, as no work is available or even imminently available, raising UI payments would be an administratively easy way to get more money to people quickly. Finally, roughly half of U.S. states allow UI to be used as part of work sharing (if a firm cuts workers’ hours instead of employment, employees are eligible for UI for the lost wages). Expanding that program would help workers stay attached to firms. In all these cases, there is a need to fund these expansions at the federal level, as state UI trust funds could not handle the surge in cases along with an expanded role.
SNAP is one of the most efficient and effective automatic stabilizers in the fiscal policy toolkit. Over 38 million individuals received food aid via SNAP before this crisis. Recent legislation has waived SNAP work requirements, allowed states to increase SNAP resources to households, and provided other food security programs and resources that support pregnant women, young families, children, and the elderly. Further legislation could waive work requirements until the economy has recovered and increase the value of SNAP benefits for all participants, and even more-so for families with children, as a simple mechanism to target cash-like resources to low-income families.
Q: Should direct checks be sent to all U.S. households?
A: We know that targeted help will not reach all who need it, so we should send help to all families. Such a plan would help those struggling but also provide additional purchasing power in the economy once social restrictions are lifted.
Millions of Americans who do not lose jobs may still lose income, tips, commissions, and hours. Too many American households live on the financial edge and will require support whether or not they meet eligibility requirements for safety net programs. As such, sending resources directly to all (or all but the highest income) households could provide a crucial cushion. A sound solution gaining momentum is to send checks (proposals range from $1,000 to $2,000) to households as fast as possible to help families immediately.
Speed is the essential parameter. Trying to target the checks based on prior income may slow the disbursement of funds and may be inaccurate as household’s circumstances have changed; it may be simpler to claw back some of the money for high income households based on 2020 taxes. Some proposals called for phasing in the size of the check with income (so those with little to no tax liability get less). There is no reasonable justification for the latter, as a payment based on prior income cannot have an incentive effect (one cannot go back and earn more in the past). Because the federal government may not be able to get checks to people fast enough, one option to quickly help the most vulnerable households would be to also provide cash to all SNAP and TANF households by putting non-restricted cash on existing electronic benefit transfer cards. As noted above, using economic outcomes to determine if more checks should be sent would ensure that Americans receive aid if the economy deteriorates sharply.
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