Joe Biden’s strategy for the US economy is the most radical departure from prevailing policies since Ronald Reagan’s free market reforms 40 years ago. With plans for public borrowing and spending on a scale not seen since the second world war, the administration is undertaking a huge fiscal experiment. The whole world is watching.
If Biden’s coronavirus recovery plans are vindicated, they will demonstrate it is possible to “build back better” from the pandemic and that advanced economies have been overly obsessed with inflation for the past 30 years. It will put government back at the heart of day-to-day economic management. If the plan comes off, it will show that unnecessary timidity in recent decades has let millions suffer unnecessary unemployment, starved many areas of opportunities for improved living standards and widened inequalities.
But if the strategy fails, ending in overheating, high inflation, financial instability and the economics of the 1970s, the US experiment of 2021 will go down as one of the biggest own goals of economic policymaking since François Mitterrand’s failed reflation in France in 1981. Biden’s $1.9tn borrowing and spending plans have not been dreamt up on university campuses but are the result of a delicate political balance in a divided Congress.
Any new stimulus figure much lower than the planned 9 per cent of gross domestic product risks losing more votes from Democrats than it would gain from Republicans. “This is what he can get done when he has razor-thin majorities to deal with,” says Professor Kenneth Rogoff of Harvard University.
The new administration is making the case that the stimulus plan is an extension of the “high-pressure economy” Janet Yellen advocated in 2016, when she chaired the Federal Reserve, which was a response to the insipid recovery after the financial crisis. The administration believes that this is the best way to ensure a full recovery from the Covid-19 crisis with few lasting scars.
Now with Yellen as Treasury secretary, “act big” is the new slogan and the US economic policymaking establishment is on board. Jay Powell, the current Fed chairman, stressed last week the need for “patiently accommodative” monetary policy, signalling that the US central bank was in no mood to take away the punchbowl by raising interest rates before the party got going. Growth expectations The plans have left economic forecasters in a quandary.
The IMF and OECD have recommended looser fiscal policy to aid the recovery, but not so far on the scale planned by the US. The non-partisan Congressional Budget Office forecasts, which included only the final Trump stimulus in its latest forecasts, already expected the US economy to grow sufficiently fast this year to regain the pre-pandemic level of output by summer.
It also expected the US economy to recover all of the lost ground from the Covid-19 pandemic by 2025 with no permanent scars. If former president Donald Trump’s stimulus plans were sufficient to make up the lost ground, the question is what an additional stimulus of 9 per cent of national income will achieve.
The CBO has not yet given its view, but academics and private sector economists are increasingly taking a stance. Consensus Economics reports positively that independent forecasters have raised their expectations of US economic growth for 2021 and 2022 with barely any additional inflation. Ellen Zentner, chief US economist of Morgan Stanley, argues that the high-pressure economy will raise US output by the end of next year almost 3 per cent above the level that she had pencilled in before the coronavirus crisis.
She assumes the Fed would not seek to rein in the rapid growth rates. The contrast with the 2008-09 financial crisis is striking. In the decade after that crisis, the US economy, along with almost all other advanced economies, did not manage to return to the pre-crisis path of output. In the halls of academia, the vast scale of the US experiment is much more controversial and has created shifts in allegiances within the economics profession that few could have predicted even a month ago.
There is little surprise that Paul Krugman, the economics Nobel laureate, would support the Biden plan, arguing that there was only weak evidence for the theory that low unemployment rates raise wages and then inflation. This view, he said, was “mostly wrong”, leading to policy being overly “constrained by the fear of a ’70s repeat”.
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