Avoid spending like there's no tomorrow

The bulk of the fiscal packages announced to counter the economic impact of COVID19 are therefore not stimulus as such because they will not rouse economic activity, but will hopefully instead keep the economy on life support.   Hence terming these packages fiscal stimulus is a misnomer.

The one element that is in the nature of old style Keynesian stimulus is the cash handouts to pensioners and other welfare recipients.  Cash handouts to households are also a key element of the United States government’s response. 

Why governments have chosen this fiscal option is puzzling for several reasons.  First, it is at odds with government health restrictions, including stay at home advice and limits on provision of goods and services to essential services.  Pensioners of all people, for instance, should not be out shopping. 

Second, economic theory suggests that as these payments are one-off and hence temporary, they are more likely to be saved than spent, yet at significant cost to government saving.  If they are spent, it will add to imports, detracting from Australia’s GDP.

Avoid further fiscal stimulus

While a recession seems inevitable, a depression seems most unlikely.  Even so, an interesting and much neglected historical economic fact is that there was no fiscal stimulus response to the forgotten, albeit short-lived, depression in the United States in 1920-21, just after the Spanish flu pandemic and around a decade before the Great Depression.  At that time there was a close to one third fall in US industrial production, a near halving of the Dow Jones Industrial Index, a collapse in corporate profits and sudden rise in unemployment. 

Instead of fiscal stimulus, the administrations of Presidents Woodrow Wilson and Warren Harding responded by balancing the federal budget, while the Federal Reserve raised interest rates instead of lowering them.  Within eighteen months that depression was over.

Times and the structure of economies have changed markedly since then of course, a key difference being that economies are now more internationally integrated.  Yet it is worth remembering that there was no federal fiscal stimulus response to the 1997-98 Asian Crisis, which the economy weathered well.

Continuing to ramp up ‘stimulus’ elements in any future federal and state fiscal packages to encourage aggregate spending, as several economists have called for, runs the risk of severely hampering future economic performance, as happened post GFC.  

A “whatever it takes” fiscal mindset easily translates to “spend like there’s no tomorrow”.  But experience tells us there’s always a future cost when there’s a rush of red ink to policymakers’ heads.