There is an extensive belief that: if the government can hand out money in a crisis, why it can’t do more of that during normal times? It’s quite a common belief because nobody learns that economics is the study of trade-offs. A former student delighted the nerd in me and emailed me to help understand the consequences of such a policy of direct cash “stimulus” to alleviate the crisis. Here was my response:
The idea should raise red flags, but how harmful the results are can depend on a variety of other factors.
The basic economic logic is that because money is not wealth, simply injecting money into the economy (if there are no other mitigating factors) will increase price inflation.
However, the Keynesian explanation (the economic theory behind this sort of stimulus/bail out) does seem plausible on first glance. Advocates of this would say something like:
“Because business are not able to keep staff productive and working (both because they stay home for safety, and because their clients are staying home and not buying stuff), a direct cash payment to people will both help them survive financially, but will also encourage people to spend that money, which means that the coffee shop actually has more money coming in again, which means that they are then able to hire more workers, and so forth.”
Again, that seems to be plausible. It seems both benevolent to individuals and is alleged to spur economic growth more generally. I’ll tackle both of those two things in turn.
First…
The problem is that in economics there are always trade-offs. First of all, where is the money coming from? Well, it’s coming from either…
1) current taxpayers (“here’s your money back”)
2) from future taxpayers (debt)
3) from printing money out of “thin air” (which is a tax on people’s money because it causes the value of money to decrease…inflation).
I could argue about the problems with the first source, but I don’t think I need to. The problem is, of course, that the bailout money will have to come from the latter two because the U.S. government already spends (annually) all its tax revenue and then another half-trillion on top of that. So it will borrow (which transfers a debt burden to future generations) or print (which causes price inflation).
Actually, the latter two will be essentially the exact same thing. When the government borrows money, it gets it out of thin air from the Federal Reserve, which then “buys” the debt by “making” the money (adding zeros to the Treasury’s balance). The Fed may or may not then sell those bonds to a bank, which would pull already existing money out of circulation and mitigate price inflation, but it doesn’t have to. It almost certainly won’t in this case, since their goal is more money in the economy.
So the inflationary effects are caused by either option 2 or 3 above.
Of course, many people will likely be legitimately helped in the short run. Again, there are benefits, and there are costs.
As for the inflation issue, there is legitimate concern.
In the 2008 crisis, there were bailouts, but most of the newly created money went straight to banks, which then held on to it because they were worried about more instability, which I think really restricted the price inflation we saw then (money doesn’t cause price inflation if it doesn’t circulate into the economy). This time, if they give so much directly to Americans, I’d be concerned of at least a short run of rapid inflation (probably not hyper inflation). I can’t predict the future, because there may be forces at work I don’t see. For example, if Americans hold on to a lot of that cash for a while and don’t spend it, you may not see the price inflation right away, it may just cause a slightly higher inflation rate in the mid- to longer- term. But historically, times when governments have started injecting money into the economy directly has always caused a period of rapid, or even hyper inflation, especially when the economy is contracting the production of goods and services (producing less), as it is right now with so many people staying home. The more they give, the worse the potential consequences. Worse case in history: the Weimar government paying German workers in the Ruhr not to go to work in 1923–that caused hyperinflation worse than anything the world has ever seen. Do I think it’d be that bad here? I highly doubt it, but obviously any price inflation affects the very people intended to be helped.
And that gives us the framework for understanding the second part:
Second…
On the broader goal that this is supposed to stimulate economic growth (the Keynesian idea of “priming the pump”—technically called creating “liquidity”), or, at least, slow the economic recession, that goal is offset by inflationary effects. People aren’t made better off when prices increase, for obvious reasons.
But what about keeping businesses open and so forth? Well, yes, some business may stay open that might have closed. Some workers might remain hired that would have been fired. I grant that. Again, economics is about trade-offs.
Fundamentally, however, you have to look at other costs–what is given up. We’ve looked at inflation. Let’s look at another one, and this gets at the very core of the matter:
People buying things isn’t what causes economic growth or a rising standard of living. You could give everyone 100 oz of gold in the Middle Ages, and sure, they could all go buy more shoes, clothes, horses, etc, right away before prices caught up and the gold became less valuable. The blacksmiths and cobblers and seamstresses would have been delighted…for just a little while. But what actually causes the standard of living to rise? It was the saving and investing that allowed for innovative technological advances. When saving is channeled into research and development to create new capital (machinery, computers, etc), that’s what creates more economic efficiency and raises real (inflation-adjusted) wages.
If everyone is out spending a lot of money, they are saving less money, which means there is less available for those investments that take a while to develop or invent. Imagine if Thomas Edison had just spent all the money on fancy clothes and shoes and nice homes that sustained him and financed his research while he worked on the light bulb! No light bulb, at least from him.
Back to our previous medieval example… let’s say one person chooses to take 100 oz of gold and use it to pay for his basic necessities for a year while he works on a new fertilizer that will ultimately quadruple agricultural output, making food cheaper and less labor-intensive for everyone. That one person has done more for everyone else because he invested his money rather than spent it. That’s how the economy grows.
A couple final points:
– Inflation encourages spending rather than saving. If you know your money is going to buy less in the future, are you more likely to buy stuff now or wait to buy stuff later?
– Spending reduces the amount of money that goes into investment.
Long story short: cash like that might really help some individuals and small businesses in the short run (and who’s complaining about getting an unexpected check?). In the short run, it might also cause some serious price inflation, but even if it doesn’t (and I certainly hope not), you will certainly see higher price inflation in the mid to longer run. And ultimately a bunch of spending makes it look like there’s a flurry of economic activity, but under the surface, it’s like a college student getting a bunch of extra money and going out and spending it all. Things seem really good for a time–nice car, nice TV, etc–but really, he is no better off economically in the long term.
(And none of this looks at the consequences of adding that amount onto the federal debt. But this is way too long already.)
