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Why Biden's $1.9trn bill represents a decisive shift in economic thinking

By recognising that public debt doesn't matter, and abandoning work incentives as a design principle, the stimulus amounts to a significant break with neoliberalism.

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The “American Rescue Plan Act” (ARPA) – the Biden administration’s $1.9trn relief package, signed into law on 11 March – has been described by the White House as “one of the most consequential and most progressive pieces of legislation in American history”. Among other things, the bill provides direct payments to most Americans and expands support for families with children.

Some are frustrated about Biden’s surrender on the proposal to introduce a $15 minimum wage, the scaled-back unemployment insurance, the failure to turn the child tax credit into a universal child allowance, and that much of the spending in the bill is due to phase out over the next year or two. Others have hailed the bill as a “paradigm shift” and compared it to FDR’s New Deal programmes.

Many of the criticisms are valid. But despite its shortcomings and compromises, the bill represents a decisive break with neoliberalism and prevailing macroeconomic orthodoxy of the past 30 years. Both the Clinton and Obama administrations entered office with ambitious spending plans, only to abandon or sharply curtail them (respectively), and instead embrace a politics of austerity and deficit reduction.

From this point of view, that the Biden administration not only managed to push through an increase in public spending of close to 10 per cent of GDP, but did so without any promises of longer-term deficit reduction, suggests a fundamental shift in economic thinking. That economists such as Lawrence Summers, who was Treasury secretary under Clinton, have been ignored in favour of progressives like Heather Boushey and Jared Bernstein, and deficit hawks including the Committee for a Responsible Federal Budget have been left screeching irrelevantly from the sidelines, isn’t just gratifying as spectacle; it suggests a significant shift in the centre of gravity of economic policy debates.

Over the past generation, macroeconomic policy discussions have been based on a textbook catechism that goes something like this:

Over the long run, potential GDP – an estimate of the maximum output the economy can sustainably produce – grows at a rate dictated by “supply-side factors”, such as technological advances, the adequacy of infrastructure and demographics. In the short term, there are random events – from asset bubbles to oil price hikes and pandemics – that can cause actual output to deviate from potential, resulting in a higher or lower rate of inflation.

These fluctuations in spending – above or below potential – are more or less symmetrical, both in frequency and in cost, and the job of the central bank is to adjust interest rates to minimise the deviations (raising interest rates to rein in spending and inflation, and lowering rates to stimulate spending).

The best short-term measure of how close the economy is to its potential is the unemployment rate, which is low when actual spending is close to potential, and high if spending levels fall.

The government budget balance, meanwhile, should not be used to stabilise demand, by, for instance, increasing spending in a recession. Rather, it should be kept at a level that ensures a stable or falling debt ratio; large fiscal deficits may be very costly.

Finally, while it may be necessary for the government to stabilise overall spending in the economy, this should be done in a way that minimises “distortions” of the pattern of economic activity — the job of macroeconomic policy is to keep the overall level of spending on the right path, while leaving choices about what is produced and how to the market.

It’s especially important that measures to stabilise demand do not reduce the incentive to work.

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Policy debates have been moving away from this catechism for a while, but in both its scale and design, ARPA is the most consequential rejection of it yet. Without being described as such, it is a decisive recognition of some of the arguments progressive economists have been making for years. Among these are:

Periods of too little spending are much more frequent, persistent and damaging than periods of too much spending.

“Overheating” and runaway inflation are the risks invoked by critics of a large government stimulus, who think it will boost demand too much. But while too much spending may have short-term costs in higher inflation, inflated asset prices and a redistribution of income toward relatively scarce factors (eg, urban land), it is also associated with a long-term increase in productive capacity one that may eventually close the inflationary gap on its own. And to the extent that overheating is a problem, it is much easier to stem the flow of spending than to restart it.

 

A full employment or “high pressure” economy has advantages that go well beyond the direct benefits of higher incomes and output.

There are also major implications for the distribution of income. Those who are most disadvantaged in the labour market are the ones who benefit most from very low levels of unemployment. The Second World War experience, and the subsequent evolution of the racial wage gap, suggests that, historically, sustained tight labour markets have been the most powerful force for closing the gap between black and white wages.

 

Public debt doesn’t matter.

In the push for the Rescue Plan neither the administration nor the Congressional leadership seemed to even gesture towards deficit reduction – not even a pro forma comment that it might be desirable in principle or in the long run. This reflects the experience of the past decade, when countries around the world have greatly increased their public debt without experiencing any of the costs – interest rate spikes, rising inflation, collapsing currencies – that high debt was supposed to impose.

 

Work incentives don’t matter.

For decades, welfare measures in the US have been carefully tailored to ensure that they did not broaden people’s choices beyond wage labour. The commitment to maintaining work incentives was strong enough to justify effectively cutting off cash assistance to families without anyone in paid employment – which, of course, includes the poorest. The flat $600 pandemic unemployment insurance was a radical departure from this: reaching everyone who was out of work took priority over ensuring that no one was left better off than they would be with a job. The empirical evidence that this had minimal effect on employment is informative about income-support programmes in general. Similarly, by allowing families with no wages to get the full benefit, the child tax credit effectively abandons work incentives as a design principle. As many have pointed out, this is directionally 180 degrees from Clinton-era “welfare reform”. 

 

Direct, visible spending is better than indirect spending or spending aimed at altering incentives.

Compared to the debates over the 2009 stimulus package at the start of the Obama administration, it’s striking how much this Rescue Plan leans into direct, visible payments to households, reflecting a view that making the payments more salient is a good thing, not a bad thing.

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In other areas, the conceptual framework hasn’t moved as far, though there has been progress:

Weak demand is an ongoing problem, not just a short-term one.

Probably the most serious criticism of the ARPA is that so many of its provisions are set to phase out at specific dates when they could be permanent (the child tax credit) or linked to economic conditions (the unemployment insurance provisions). This suggests an implicit view that the problems of weak demand and income insecurity are specific to the coronavirus, rather than acute forms of a chronic condition.

Still, many of the arguments in support of the bill are not specific to the pandemic, and clearly imply that these measures ought to be permanent. If the child tax credit will cut child poverty by half, why would you want to do that for only one year? If a substantial part of the Rescue Plan should be permanent, that implies a permanently larger flow of public spending.

 

The public sector has capacities the private sector lacks.

While Biden’s bill is a big step forward from Obama’s 2009 package in many ways, one thing they have in common is a relative lack of direct public provision. The public health measures are an exception, of course, and the aid to state and local governments – a welcome contrast with Obama’s bill – is public spending at one remove, but the great majority of the money is going to boost private spending. That’s not necessarily a bad thing in this specific context, but it does suggest that, unlike the case with public debt, the institutional and ideological obstacles to shifting activities from for-profit to public provision are still formidable.

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How do we think about public debt and deficits once we abandon the idea that a constant debt-GDP ratio is a hard constraint? One possibility is that we think the deficit matters, but debt does not, just as we now think that the rate of inflation matters but the absolute price level does not. To earlier generations of economists, the idea that prices could just rise forever without limit would have seemed insane. But today we find it perfectly reasonable, as long as the rise over any given period is not too great. Perhaps we’ll come to the same view of public debt.

To the extent that we do care about the debt-GDP ratio, we need to foreground that its growth over time depends as much on interest, inflation and growth rates as it does on new borrowing. For the moment, that interest rates are much lower than growth rates is enough to convince people past concerns were overblown. But to regard that as a permanent rather than contingent solution, we need, at least, to get rid of the idea of a natural rate of interest.

What we need now are mainstream macroeconomic theories that systematise and generalise the reasoning that justifies a great expansion of public spending, unconstrained by conventional estimates of potential output, public debt or the need to preserve labour-market incentives.

To be clear, the Rescue Plan did not pass because some economists out-argued other economists. It was a political outcome driven by political conditions and political work. Most obviously, it’s hard to imagine this Biden administration without the two Bernie Sanders campaigns that preceded it. (In the president’s speech after signing the bill, Sanders was the second person credited.) If it’s true, as reported, that the Senate majority leader Chuck Schumer kept expanded unemployment benefits in the bill only by threatening the “moderate” Democrat Joe Manchin that the legislation would not pass the House without them, then Alexandria Ocasio-Cortez and the rest of the progressive “Squad”  also deserve credit.

The circumstances of the past year are certainly exceptional, but that doesn’t mean we can’t learn from them. For the past generation, macroeconomic theory has been largely an abstracted parable of the 1970s, when high interest rates (supposedly) saved us from inflation. With luck, perhaps the next generation will learn macroeconomics as a parable of our own time, when big deficits saved us from secular stagnation and the coronavirus.

 

This is an abridged and adapted version of an essay that originally appeared on The Slack Wire.

JW Mason is an associate professor of economics at John Jay College, City University of New York and a fellow at the Roosevelt Institute.