Biden risks the future to juice the present
America is about to run a pretty wild experiment. And hardly a riskless one. After the nearly $2 trillion American Rescue Plan is passed and signed, Washington will have committed more than $5 trillion in fiscal support since the start of the COVID-19 pandemic. That's an amount equal to 25 percent of the pre-pandemic 2019 economy. No other country in the world is pumping money into their economy quite like the United States. Even if the ginormous ARP were half or even a quarter of its current size, the economy's output gap — the difference between where the economy is and where it probably should be based on its underlying potential — would probably be closed sometime this year.
So this grand fiscal experiment is a choice rather than a necessity. The cautionary case against making that choice is straightforward: A tsunami of nearly $2 trillion of government spending, when combined with some $2 trillion in excess savings, could fuel such a spending binge in a reopened economy that inflation will soar like crazy. If that surge is beyond current expectations, the Federal Reserve might have to raise interest rates faster and farther than now expected, short-circuiting the strong jobs and wage recovery. (And all this would be happening, as I wrote recently in The Week, against longer-term changes in demographics and globalization that could make the advanced economies more susceptible to inflation.)
But maybe not. The Fed has become more tolerant of a bit more inflation, and Wall Street has been sanguine about a lot more federal spending. It's become more and more common to see banks forecast 6 percent or higher economic growth this year, even adjusted for inflation, along with some pretty rosy predictions about employment. If you assume full employment means a jobless rate of less than 4 percent, then the U.S. could be back to full employment by 2023, if not sooner. A restored job market in just three years or so after a historic economic shock is pretty impressive. It took a decade for that after the 2007-2009 financial crisis. But faster growth driven by a spending splurge isn't necessarily better if it spurs pre-emptive action by the Fed. The post-crisis jobs recovery was slow, but it just kept going and going. By the end, low-wage workers were receiving the biggest pay gains.
Like I said, this is an experiment. We just don't know how the economy is going to react exactly. It's worth noting that one reason Democrats have been so relaxed about rising deficits and debt is that the government bond market has seemed unconcerned about all the spending — and the massive borrowing that will finance it. Maybe too relaxed. Long-term interest rates have jumped in recent weeks. Now that's most likely because the economy is strengthening. But whether it becomes more than that is worth watching.
Whatever the results of this experiment, Americans shouldn't learn the lesson that spending is a risk-free proposition. Nor should they learn the lesson that economic growth is easy, accomplished merely by spending lots of money. Indeed, even the most bullish banks expect the economy to return to 2 percent-ish, "new normal" growth in 2023 and beyond. So same-old, same-old economy, just with a whole lot more debt.
Biden and congressional Democrats should think hard about that impending return to slow-growth normalcy when planning their next big spending package. That's the one that will probably have a big infrastructure and clean-energy investment component. It might be another $2 trillion package or more, though probably offset by some tax hikes. Team Biden should be careful with those tax hikes so they minimize any new burdens on business investment. The Tax Foundation points out that raising the federal corporate rate to 28 percent from 21 percent would boost the U.S. federal-state combined tax rate to the highest among rich countries. And it should think hard about the wisdom of reversing some Trump-era environmental deregulation efforts that would make an infrastructure buildout slower and pricier. No need to make this experiment riskier than it has to be.