According to my baseline forecast, the pre-crisis level of U.S. gross domestic product of the fourth quarter of 2019 will not be reached until early 2022. Although the U.S. economy is likely to grow at solid rates in the coming years, an additional fiscal stimulus program could accelerate the recovery. Simple scenario analyses suggest that with a $500 billion program, the U.S. economy could grow next year by up to three percentage points more than in my baseline forecast. Although such calculations are primarily illustrative and forecasts are currently subject to considerable uncertainty, the potentially significant growth effect of a fiscal stimulus program is remarkable.
In my baseline forecast for the United States, the pre-crisis level of gross domestic product in the fourth quarter of 2019 will not be reached again until early 2022. The extent of the crisis becomes even clearer if the hypothetical growth path of the US economy at the turn of 2019/2020 is considered. Compared with the forecasts made at that time, for example by the International Monetary Fund (IMF), gross domestic product in 2020 is likely to be more than five percent below the level expected before the pandemic (see Figure below). In fall 2019, the International Monetary Fund (IMF) had predicted growth rates of 2.0 and 1.7 percent for 2020 and 2021 (see IMF (2019): World Economic Outlook, October 2019: Global Manufacturing Downturn, Rising Trade Barriers). For the period 2022-2024, the IMF assumed growth rates of 1.6 percent each. The growth gaps in 2021 and 2022 are also likely to remain high and only decline gradually. From today’s perspective, it is quite possible that these gaps will still not be closed in 2024 – that is, at the end of Joe Biden’s term of office.
Also compared with potential output – that is, the theoretical production level of an economy at which normal utilization of the factors of production can be expected – a significant gap opens up for 2020. While this so-called output gap was still slightly positive according to data from the Congressional Budget Office in 2019, it has become strongly negative in the year under review due to high unemployment and underutilization of production capital, and is likely to be just over 4%. The output gap is also likely to remain negative for some years to come. The growth losses from 2020 will therefore not be made up for some time yet. Against this backdrop, there has been an intensive political and scientific debate about the possible benefits of additional fiscal stimulus measures since the outbreak of the pandemic.
A new fiscal aid and stimulus program?
Even if my baseline forecast does not assume any further extensive fiscal measures, it is possible that the political actors will agree on a further aid and stimulus program. In early December, an agreement between the political parties seemed possible. In the following, I would like to illustrate how a hypothetical stimulus package in the amount of USD 600 billion could affect economic development next year. It should be noted that it is difficult to estimate the economic effects of higher public spending and that in some cases very different effects are published in academic studies (for useful overviews, see for example Ramey and Zubairy (2018): “Government Spending Multipliers in Good Times and in Bad: Evidence from US Historical Data”, Journal of Political Economy, Vol. 126(2); Whalen and Reichling (2015): “The Fiscal Multiplier and Economic Policy Analysis in the United States”, Congressional Budget Office, Working Paper 2015-02).
Uncertain level of the fiscal multiplier
The so-called fiscal multiplier, that is the change in gross domestic product triggered by a one dollar increase in government spending, cannot be observed directly. By means of empirical studies or theoretical simulations it can be tried to estimate approximately by how much the gross domestic product changes as a result of higher government spending. The results vary greatly depending on the method and the time period/country studied and range from almost 0 to about 3 – i.e. from no effect to a very strong stimulation of the economy. At least three reasons play a role in why the fiscal multiplier can vary from case to case. First, the composition of the fiscal stimulus measures often varies; but the effect on economic performance depends on whether the financial resources are allocated to roads, renewable energies, more government employees, transfer payments to households, etc. Second, there are often delays until a measure proposed by the government finds a majority in the political process and is then implemented. Such delays are particularly common in infrastructure spending and also occur when maintenance work is brought forward. This reduces their suitability as a short-term stimulus measure, even though infrastructure investments often have a positive effect on economic growth in the longer term. Third, the stimulating effect may also depend on whether an economy is in recession or in a boom phase. In a boom phase, for example, private investment could be crowded out – especially because the central bank feels compelled to pursue a more restrictive monetary policy due to the expansive fiscal policy, which increases the interest costs for financing private investment. In the current environment following a dramatic slump in economic output and low interest rates, this crowding out effect is likely to be rather small. However, it should be noted that the current crisis affects personal services to a significant extent. Residential construction, on the other hand, is booming due to very low interest rates, and corporate investments have also been developing solidly since the summer of the current year. Capacities are therefore not underutilized to the same extent in all economic sectors.
Scenario analyses help illustrate the possible range of the fiscal multiplier
These uncertainties can be taken into account by considering different scenarios in which the magnitude and duration of the multiplier effect of government spending is varied when estimating the multiplier effect. The following analysis examines whether the US economy could approach the growth path expected at the end of 2019 more quickly with a fiscal stimulus program than with the baseline forecast, in which no stimulus program is assumed. Since the composition of any program is unknown and the magnitude of the multiplier effect can vary considerably, an assumption must be made for the magnitude and various scenarios must be demonstrated by means of a range of possible multiplier effects. The assumed amount of the impulse program is 500 billion US dollars – i.e. somewhat more than two percent of the gross domestic product. It is assumed that this sum will be decided quickly and reach people and companies in the first half of 2021. The range of the assumed multiplier effects is based on the multiplier effects used by the American Congressional Budget Office (CBO) – the independent audit office of the US Congress – to assess fiscal stimulus measures (see Whalen and Reichling (2015): “The Fiscal Multiplier and Economic Policy Analysis in the United States”, Congressional Budget Office, Working Paper 2015-02). In 2020, the CBO has adjusted the multiplier effects as the pandemic and measures to contain it are likely to restrict economic activity and thus reduce the stimulus effects. This paper assumes that the pandemic will gradually subside over the coming year – also as a result of the availability of vaccines – and that the multiplier effects will be reduced only slightly. In an environment where the economy is still well below potential output and interest rates are still likely to be very low, multiplier effects between 0.5 and 2.5 are expected to have an average value of 1.5. In the course of 2023, economic output will probably slowly approach its potential again and interest rates are likely to rise slowly. Displacement effects on private investment and consumption could then once again play a minor role.
Significant effects of a fiscal impulse possible
Under these assumptions, the US economy would grow by around three percentage points more strongly under the scenario with an average multiplier effect by 2022 than it would without fiscal stimulus (see Figure below). However, with a low multiplier effect it would be significantly less (just over one percent in the case of a stimulus program amounting to three percent of GDP), and with a high multiplier effect it would be significantly more (just over five percent). Stimulus measures could thus potentially close the growth gap significantly faster than under the baseline scenario without fiscal stimulus. It is clear, however, that the magnitude of the multiplier effect and of other economic developments is very uncertain. How do you think the political parties in the USA will decide?
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