I’m trying to do something positive every day during the social distancing phase of the pandemic and I’ve regularly been reading of people complaining about what the federal government is doing to respond to the economy’s current free fall. This is a pretty dry topic so I’m going to try to make this fun.
First off, fiscal policy is different from monetary policy. Fiscal policy is anything related to government spending or taxes. Expansionary fiscal policy is what the government uses to improve the economy and it refers to tax cuts or spending increases like the current plan of the government sending everyone cash, providing low interest loans to businesses currently in trouble, or a payroll tax cut. Contractionary fiscal policy refers to tax increases or spending cuts like anything to do with the reducing the deficit. Fiscal policy falls on Congress.
Monetary policy is technically a part of the federal government’s job, but it is entirely run by the Federal Reserve which is bank of all banks and is largely independent from politics. Congress and the President approve who sits on the Federal Reserve Board and they make decisions about monetary policy. Monetary policy is what people refer to as “printing money”, which is a misnomer since 98% of all money is digital at this point (very little money is actually printed anymore). The Federal Reserve has a few powerful tools at its disposal to impact how the economy.
One of the biggest is that it can lower or raise interest rates which creates quick incentives to either save or spend money. Lower interest rates make it easier for people to buy houses or refinance their current houses by getting new loans or changing how their current loan is functioning. Debt financed spending on durable goods like houses flows into the economy in the form of realtor commissions, construction jobs, new purchases, more tax revenue for local governments, etc. Refinancing a house lowers mortgage rates saving them money on their monthly payments which continues to prime the pipe of money flowing elsewhere. Housing is generally everyone’s biggest expense so saving a few hundred dollars on one’s mortgage in the short term or thousands long term has a huge effect on one’s financial well-being.
Lower interest rates also reduce one’s incentive to save money in their savings accounts since they’re not earning much. It encourages you to either spend your money or invest it in the stock market, both of which stimulate the economy.
Higher interest rates have the opposite effect when the economy is doing really well. When the Federal Reserve wants to reduce inflation, it puts the brakes on the economy by raising interest rates. Higher interest rates make it harder to get a mortgage, helps people earn money in their bank’s savings accounts, both of which reduce one’s propensity to spend.
The Fed has other tools at its disposal, they can increase purchases of bond buying which increases personal wealth if one is invested in bonds. They can lend money to the federal government to spend or cut taxes at extremely low interest rates. Another tool is the reserve requirement. Reserve requirements going lower allows banks to lend more to people again buying things through debt like cars, boats, and houses since banks don’t have to keep as much money in reserves.
As you can see, the Fed’s decisions has massive implications on the health of the economy.
Now, let’s get into misconceptions!
“Gubmint’s just gonna keep printing money!” — I think people object to this because it’s generally considered to be a bad thing when the government prints a bunch of money. It’s not. Hyperinflation is a really bad thing, that’s a complete failure of money supply management. This situation is when inflation reaches 100% or more and people start using $1,000,000 bills to buy groceries. It’s unlikely that this is going to happen anytime soon though, especially in America. There are plenty of criticisms of the Federal Reserve, but inflation generally only occurs when the economy is going really well (right now it’s not going well). Inflation has been around 2% for the past decade and inflation itself is not a bad thing. It’s not some dark magic that raises prices, inflation refers to prices of goods and services going up due to the law of supply and demand.
When there is more money in circulation, demand increases which incentivizes business owners to raise their prices to equilibrium. Higher wages raises demand which raises prices. Richer parts of the country have higher prices because business owners know they can charge more and earn more money, they in turn raise wages to compete for labor, lowering poverty. Poorer parts of the country have lower prices because they’re competing for customers.
“How’re they gonna pay for all that?” — I hate this response. I once had a friend yell this at me when we were talking politics. While this is hard for people to understand, the federal government doesn’t have to repay its loans and we haven’t run a fiscally balanced federal budget in this country for decades. People think that we’re borrowing all of this money from China and other countries, but that’s not true. The federal government has “printed” about 70% of its debt, it is literally money that we owe ourselves so no other country is going to call on the debt. The other 30% of the debt is owned by foreign investors and that money goes back to them anyway since we buy their products. We buy so much stuff from China that they’re never going to ask us to pay the debt back because that would hurt their economy even more.
If China said that they want their $2 trillion back over the course of ten years, we would have to raise taxes and cut spending by $200 billion per year (plus interest). Depressing the economy by that amount would reduce demand for Chinese goods and services.
“I don’t think we should send out checks, then people won’t want to work” — people will work when there are jobs available to them. Think about how the economy was going in January 2020, unemployment was below 4%. During the midst of the Great Recession, unemployment was around 10%. Today, unemployment is hovering around 13% (really bad!). The difference in unemployment refers to the people that found jobs because the jobs were available. On top of that, a $1,200 check is more of a humanitarian relief effort to people who can’t work right now like those who work at restaurants or gyms. Other jobs have simply disappeared because demand has fallen, people have died, and wages have dropped.
“People should be required to work to get government assistance” — again, where are they going to work while the economy is shutting down? If you talk to fiscal stimulus experts, they would argue that the best government policy to improve an economy is on that gets money in the hands of people with a high propensity to spend. I still have a job, but if given $1,200, I can think of a bunch of things to spend money on. Stock prices are at an all time low, I need a new suit due to losing a bunch of weight, and I would be happy to spend the rest on take out and food delivery. Most people can’t afford a sudden $400 expense so there are a lot of people suffering right now who could use any extra help they can get.
“They bailed out the stock market with $1.5 trillion?” — this is true, this did happen, but it wasn’t a bailout. The Federal Reserve, which is an independent agency of the federal government, sent out $1.5 trillion in short term loans to banks which is a good thing since so many banks have a lot of their assets tied up in bonds. Banks needed short term loans to be able to meet the need for money if a bunch of people tried to take their money out of the banks all at once (you’re money is at Bill’s house and Fred’s house). This didn’t add to the national debt, which doesn’t matter all that much, banks use debt all the time
