President Biden’s guiding principle on federal budgeting appears to be that it is better to go too big than too small. Taking this idea to an extreme, as he is now doing, will cost the country dearly by weighing down long-run economic performance. It will also likely cost the Democrats next year’s midterm elections.
Following the 2008 housing and credit market bust, the United States experienced its slowest economic recovery on record. The key lesson that Biden appears to have drawn from that experience is that President Obama’s $800 billion stimulus, the 2009 America Recovery and Reinvestment Act, was too timid for the task. If only Obama had acted more boldly, so the argument goes, the country would have recovered more rapidly from what was up to then its deepest post-war economic recession.
“It wasn’t quite big enough,” Biden explained of the 2009 stimulus in February. “It stemmed the crisis, but the recovery could have been faster and even bigger. Today, we need an answer that meets the challenge of this crisis, not one that falls short.”
Twelve years later, whatever Biden’s faults, budget timidity in response to the pandemic is not one of them. Having rushed through Congress a $1.9 trillion COVID Rescue Plan in March, he is now also proposing a poorly funded Jobs Plan and a Families Plan, both of which have price tags of close to $2 trillion.
These outsized proposals come close on the heels of the $900 billion COVID relief package Congress passed in December. This implies that in 2021, the U.S. economy will receive fiscal stimulus amounting to a staggering 13 percent of GDP—the largest peacetime stimulus on record.
Such extraordinary measures might have been more defensible a year ago in the depth of the COVID recession. But now the economy is already recovering strongly from the pandemic and the Federal Reserve still has its pedal fully to the metal, adding an extraordinarily easy monetary stimulus to the administration’s fiscal measures. The last year of COVID lockdowns has also resulted in massive pent-up demand being built up in the economy. Once the American public is vaccinated, it will hardly need encouragement to spend those savings.
The danger of the outsized Biden budget stimulus is that it can soon lead to an overheated economy and intensify the current upward price pressure. After all, the estimated 2021 fiscal stimulus is around four times the size of the estimated gap between the economy’s current level and that which it could potentially reach at full employment. Whereas the 2021 fiscal stimulus will be around 13 percent of GDP, the non-partisan Congressional Budget Office estimates that the so-called output gap is currently only around 3 percent.
Another way to gauge the excessiveness of the Biden budget stimulus is to compare it to the 2009 Obama budget stimulus. In 2021, the U.S. economy will receive fiscal stimulus some 3.5 times the size of the 2009 Obama stimulus. By comparison, the current unemployment rate is 6 percent and trending down, whereas that in March 2009 was 8.5 percent and trending up.
To be sure, the Biden budget stimulus is enjoying widespread public support as people receive their $1,400 stimulus checks. It is also generally expected to produce the strongest economic boom in the past 40 years. But if that boom does produce economic overheating and inflation by year-end, it could generate a bust next year.
If inflation does accelerate later this year, the Federal Reserve will have little option but to raise interest rates in order to meet its price stability mandate. Rising interest rates in turn could very well cause the current equity and housing market bubbles—which are premised on the mistaken assumption that today’s ultra-low interest rates will last forever—to burst.
All of this suggests that we are now on course for a very strong economic boom in 2021 that will be followed by a nasty hangover in 2022. This would be particularly unfortunate for the economically vulnerable part of our population whom Biden purports to want to help. It could also endanger the Democrats’ prospects in next year’s midterm elections.
Accelerating vaccine distribution and distributing relief checks has surely bought Biden some goodwill with voters. A recession in the middle of 2022 could lose it all just as quickly.