Michelle Obama is experiencing mild depression. If she can feel depressed, I feel better about my own malaise, especially about the state of the US economy. Without additional fiscal stimulus, we will experience an economic depression, a situation where the economy lacks its own ability to recover. There are other things to feel terrible about – unnecessary deaths, inequality, school-age children falling behind, and another generation likely to incur long-term effects from sustained, high unemployment. All these painful experiences are worsened as the economy tanks further.
It’s helpful to remember Macroeconomics 101. The level of our nation’s Gross Domestic Product (essentially our national income) depends on the addition of four terms.
- Consumption of disposable goods like food, entertainment, and clothing. It is the dominant majority of our GDP, coming in at about 69% in Q2 of 2020 GDP.
- Government spending on things like transfer payments (Medicare and Medicaid), direct purchases (defense and VA Hospitals), and payrolls is the second-largest component. This includes all levels of government, from township to federal. It may surprise you that state and local spending exceeds federal spending.
- Investment by businesses and households in durable items like machinery, rental properties, and homes. And,
- The excess of exports over imports, which is usually negative in the US as we import far more than we export.
The COVID-19 pandemic has decimated the first three components of the sum, creating more than a 10% decline in the second quarter’s economic output, which will equate to an annual decline of over 30% if we continue on the current path. The pandemic’s unemployment impact battered lower-income employees, and they have the highest marginal propensity to consume. The first round of federal spending helped protect some of this consumption, but that money is gone, and our Congress is unable to agree on another round of stimulus.
Investment is driven by interest rates, and at today’s low rates, investment should be booming. But investment falls when there is uncertainty (e.g., about your future income if you are considering buying a home) or, for business investment, a current or potential decline in demand for your offerings.
Finally, our state and local governments—which must balance their budgets yearly—are hemorrhaging as the recession cuts into their tax base and therefore their ability to spend. The continued economic decline will lower tax revenue more, absent some relief from the Federal government. Already, over 1.5 million state and local government workers have been laid off.
We may get some help from the trade balance if the rest of the world’s economy recovers and buys our exports while constrained domestic consumption and investment reduces imports. But this change alone will not propel a recovery as the trade balance is a small part of GDP (-4.5% in Q2 2020).
The Federal Reserve is doing all that is can with monetary policy, so we cannot turn there for an escape route. With interest rates so low and unemployment so high, the required stimulus can only come from increased government spending. And we know that state and local governments cannot be the answer, which leaves us totally dependent on the Federal government.
To me, as an economist, the path forward is a no-brainer. First, address the pandemic. Use Federal power to fix the supply shortages that are keeping us from achieving the level and speed of testing we need; and, enforce mask usage nationally. We require seat belts and safer baby cribs and mattresses to protect lives, why not masks? Concurrently, repeat the last round of Federal stimulus, perhaps with some incremental changes. These steps should at least stabilize the economy to some degree until a vaccine is found. Yes, the steps I propose will add to the deficit, but far less than that caused by a prolonged depression. And, at negative real interest rates, the debt is cheap. If the GOP is concerned about providing too much stimulus, tie payments to the level of unemployment.
History has lessons from which we can learn. Massive fiscal spending pulled us out of the 1930s Great Depression. In the 1918 pandemic, US communities that acted most aggressively in stopping the spread through closures had the highest economic levels of vitality in future years. In the US, states that reopened too soon have the highest rates of virus today.
The political partisanship of our Congress and the GOP’s miserliness anger me. I hope I will be surprised by a sudden generosity or “ah-ha” economic insight in the GOP, but I remain doubtful. And that is why I join Michelle in being mildly depressed, about the virus, the economy, and all the pain they are creating. Mild is an understatement somedays.
Hold onto your hats. We will not see the V-shaped recovery Larry Kudlow, President Trump’s key economic advisor promises. He’s usually been wrong on the economy and policy in the past. So, prepare your strategy for a prolonged period of more of the same.