Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 404

Biden is stimulating an economy already enjoying a sugar hit

Detroit’s giant carmakers were among the US businesses tottering as the GFC took hold. About 2.6 million Americans lost their jobs over the four months from when the recession erupted in September 2008 until President Barack Obama assumed office at the start of 2009. The modelling of Christina Romer, Obama’s Chair of the Council of Economic Advisers, showed the then-US$15 trillion economy needed stimulus of about US$1.8 trillion to close the ‘output gap’ within two years.

How times change

But the Democrat-controlled Congress was infused with the era’s conventional wariness of budget deficits and government debt. Obama sought fiscal stimulus of only US$775 billion, though he expected the usual bartering among lawmakers to bloat the package to US$1 trillion. Republican outcries about government squandering swayed enough moderate Democrats, and the American Recovery and Reinvestment Act of February 2009 contained only US$725 billion in new money.

The jobless rate jumped from 8.3% that February to a then-post-war high of 10% eight months later as the number of unemployed swelled by another 3.5 million people. No surprise, the Obama stimulus of 5% of GDP has gone down in Democrat folklore as a 'measly' response that was partly to blame for the party losing Congress in the 2010 elections.

President Joe Biden appears determined not to repeat the errors made when he was Vice President. Biden is implementing a stimulus package worth 9% of GDP, even though the US economy is well past crisis-mode and the output gap – the difference between the economy’s actual and potential performance – is narrowing.

Package upon package

The recovering US$22 trillion economy is enjoying a vaccine-inspired reopening. Congress had already passed four covid-19 fiscal packages worth more than US$4 trillion that are still energising spending. The jobless rate has plunged from 14.8% in April last year to 6%. Housing prices are soaring at a 12% annual clip. The Federal Reserve has pledged to maintain its ultra-loose unconventional monetary policy.

In an era when ‘magic money’ theories dismiss concerns about government debt, the American Rescue Plan entails US$1.9 trillion of fiscal stimulus that will boost the budget shortfall for fiscal 2021 to 18% of GDP. Washington’s debt load will soar from the pre-stimulus forecast of 102% of output, most likely well past the record 107% of GDP it reached around the end of World War II.

To its proponents, the inequality-fighting stimulus gives money to poorer households, extends unemployment relief, adds funds to vaccination programs, helps schools reopen and plugs gaps in the finances of local and state governments. The mostly one-off spending is popular and presaged more durable outlays such as the infrastructure plan Biden announced on March 31 that, if passed by Congress as announced, would over the next eight years entail US$2 trillion of fresh spending. Other Democrats are calling for a US$2 trillion ‘Green New Deal’ and expanding free healthcare to those aged below 65.

With US growth surging, did it need more stimulus?

As for the macroeconomics, the emergency relief prompted Fed officials to lift their US growth forecasts for 2021 from 4.2% to 6.5%, which would be the fastest pace since 1984’s result of 7.2%. Others have raised their US growth forecasts for this year to as much as 8%, a speed last matched in 1951. Unfazed by the faster growth, Fed officials offered the ‘forward guidance’ that the US cash rate would stay at near-zero in coming years.

To its critics, much of the stimulus is a superfluous ‘sugar hit’ because the economy’s spare capacity is shrinking anyway. They worry that government debt is reaching troublesome levels. This first points to higher taxes and reduced benefits in coming years – thus the package boosts intergenerational inequality while hindering growth from 2022.

The major concern is that the package is bound to lift consumer prices. Inflation, as the Fed concedes, is most likely to accelerate beyond the Fed’s 2% target, though the central bank is unruffled by any spike in inflation above target. The critics worry that the expected rise in inflation beyond 2% proves more permanent. Biden’s relief thus could backfire if it were to spark sooner- and larger-than-expected increases in official and market interest rates. Biden’s first big legislative victory shows the new President is prepared to take risks on fiscal policy that could shape the rest of his presidency.

To settle a quibble, Obama’s stimulus should be better remembered because what was one of the largest post-war stimulus programmes set up a record US expansion. More urgently, the pandemic is far from over. Mutations that nullify the vaccine would upend the economy. Yet Biden’s stimulus might make it much harder to conjure up more huge sums without political and financial ructions. As to the threat from higher prices, hasn’t the neoliberal age of ‘independent’ central banking killed inflation? The Fed can always do a U-turn and crush inflationary pressures.

Relying on low inflationary expectations

That, however, would thump the economy and upset capital markets. The most likely outcome is less threatening. In an era of low inflationary expectations and relatively weak labour bargaining power, there appears to be enough of an output gap to make it highly likely that the expected acceleration in inflation proves fleeting and Biden’s bold approach will reinforce just how cautious Obama was 12 years ago.

 

Michael Collins is an Investment Specialist at Magellan Asset Management, a sponsor of Firstlinks. This article is for general information purposes only, not investment advice. For the full version of this article and to view sources, go to: https://www.magellangroup.com.au/insights/.

For more articles and papers from Magellan, please click here.

 

RELATED ARTICLES

Are debt and its servicing cost serious worries?

Are we underestimating the peak of the V-shaped recovery?

The coiled spring: markets are primed for the year ahead

banner

Most viewed in recent weeks

The risk-return tradeoff: What’s the right asset mix for a 5% return?

Conservative investors are forced to choose between protecting capital and accepting lower income while drawing down capital to maintain living standards or taking additional risk. How can you strike a balance?

How long will my retirement savings last?

Many self-funded retirees will outlive their savings as most men and women now aged 65 will survive at least another 20 years. Compare your spending with how much you earn to see how long your money will last.

Buffett's favourite indicator versus all-in equities

Peter Thornhill shows how his personal portfolio has thrived under an 'all-in equities' strategy, but Warren Buffett's favourite valuation indicator says stock markets are priced at their most extreme ever.

In fact, most people have no super when they die

Contrary to the popular belief supported by the 'fact base' of the Retirement Income Review, four in every five Australians aged 60 and over have no super in the period up to four years before their death.

Five timeless lessons from a life in investing

40 years of investing is distilled into five crucial lessons. An overall theme is to embrace uncertainty to make an impact on how much you earn, how much you spend, how much you save and how much risk you take.

Welcome to Firstlinks Edition 403

Most Australians hold their superannuation in a balanced fund, often 60% growth/40% defensive or 70%/30%. Lifecycle funds are also popular, where the amount in defensive assets increases with age. Employees who are not engaged with their super (and that's most people when they start full-time work) simply tick a box for the default fund selected on their behalf by their employer. Are these funds still appropriate?

  • 15 April 2021

Latest Updates

Property

Whoyagonnacall? 10 unspoken risks buying off-the-plan

All new apartment buildings have defects, and inexperienced owners assume someone else will fix them. But developers and builders will not volunteer to spend time and money unless someone fights them. Part 1

Superannuation

Super changes, the Budget and 2021 versus 2022

Josh Frydenberg's third budget contained changes to superannuation and other rules but their effective date is expected to be 1 July 2022. Take care not to confuse them with changes due on 1 July 2021.

Economy

Why don't higher prices translate into inflation? Blame hedonism

Why are prices rising but not the CPI? When we measure inflation, we aren’t measuring raw price changes, we’re measuring the pleasure-adjusted or utility-adjusted price changes, and we use it incorrectly.

Economy

Should investors brace for uncomfortably high inflation?

The global recession came quickly and deeply but it has given way to a strong rebound. What are the lessons for investors, how should a portfolio change and what role will inflation play?

Risk management

Revealed: Madoff so close to embezzling Australian investors

We are publishing this anonymously knowing it comes from an impeccable source. Bernie Madoff’s fund was almost distributed to retail Australian investors a year before the largest-ever hedge fund fraud was exposed.

Exchange traded products

How long can your LICs continue to pay dividends?

Some LICs have recently paid out more in dividends than their net profit as they have the ability to tap their retained profits and reserves. Others reduced dividends to ease the burden on cashflow and balance sheets.

SMSF strategies

How SMSF contribution reserving can use the higher caps

With the increase in the concessional cap to $27,500 on 1 July 2021, a contribution reserving strategy could allow a member to make and claim deductions for personal contributions of up to $52,500 this year.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.