COVID relief isn't stimulus, it's social insurance

It's not about priming the pump; it's about making people whole.

"High Pressure Hydraulic Pipelines CN Pipe Bender" by AMOB SA, CC PDM 1.0

A lot of people are debating Biden’s COVID relief bill as if it were fiscal stimulus. Does this make sense?

(Quick background for those who don’t know the jargon: Fiscal stimulus is when government spends money in a recession in order to restart the economy. Usually this is done in response to a deficiency in aggregate demand, which is sometimes measured with an output gap. The effectiveness of the stimulus in restarting economic activity is often measured with a fiscal multiplier.)

For example, in a much-discussed thread, macroeconomist Olivier Blanchard compares the size of the Biden relief plan to a purported output gap:

Olivier Blanchard @ojblanchard1

Let’s look at the numbers. Size does matter and can be assessed. If the economy had continued on its pre-covid trend, it would be about 900 billion dollars larger. This suggests an output gap of less than 900 billion as some sectors will not operate at full speed for some time.

Olivier Blanchard @ojblanchard1

CARES added 900 billion of stimulus in December. The Biden proposal adds 1.9 trillion. The infrastructure program to come, will add more, but let’s leave it aside. Adding the three numbers above gives: 3.6 trillion or 4 times the upper bound on the output gap.

Olivier Blanchard @ojblanchard1

How this number translates into an increase in demand this year depends on multipliers. If the average multiplier is 1 (which I think of as a conservative assumption), this implies that demand would increase by 4 times the output gap.

Blanchard’s argument that Biden’s bill is too large rests on the idea that this amount of spending will cause the economy to “overheat” — in other words, that inflation will rise. To prevent this, he suggests shrinking the size of the bill and financing more of it with taxes.

But does it make sense to think of the COVID crisis like a normal recession? In cases like the Great Recession, it’s pretty clear that the economy simply stumbles on its own — there’s no physical reason workers can’t be working, but yet there they are, sitting idly at home while corporate offices and factories and stores sit empty. The private sector is being inefficient and keeping its own resources idle for no reason. That’s why stimulus is thought of as “priming the pump” — government spending gets workers working, which makes them consume, which makes stores and offices and factories open, which pays workers more money, etc. etc. Thus the idled resources are put to use and the economy recovers.

COVID is not like that. People are avoiding consuming — eating at restaurants, getting haircuts, etc. — for a very good reason, which is fear of a real and deadly disease. People are not working for the same reason. Resources aren’t being idled by the economy’s failure to match workers with employers — they’re being idled by a plague.

That might be the answer to Austan Goolsbee’s question of why the big drop in growth in 2020 wasn’t accompanied by deflation. If this recession were really caused by a Keynesian output gap, we’d expect to see prices plunge, but they didn’t:

Austan Goolsbee @Austan_Goolsbee

@ojblanchard1 Question for @ojblanchard1 And @LHSummers: you fear that a temporary relief payment in excess of the output gap will ignite inflation. Separate from the issue of whether relief=stimulus, can you explain how the pandemic collapse at an annualized -32% did not generate deflation?

Some economists have tried to put this into formal theory. My favorite COVID theory paper is this one by Veronica Guerrieri, Guido Lorenzoni, Ludwig Straub & Iván Werning from last April. Basically, they suggest that a pandemic is like a negative supply shock that hits some parts of the economy but not others, which creates a negative demand shock in the other sectors. The overall impact on inflation is therefore ambiguous.

Guerrieri et al. also find that this decreases the size of the fiscal multiplier. If you get a check during a pandemic, you’re not going to go out and spend it at restaurants and bars, because…well, there’s a pandemic. Instead, you’re more likely to stick it in the bank, pay down debt, or pay the back rent that you owe.

In a normal recession, this is exactly what we don’t want people to do. We want them to take their government checks and go out and spend them, to restart the virtuous cycle of economic activity! But in a pandemic, it’s fine.

It’s fine because what we’re trying to do with COVID relief isn’t actually pump-priming — it’s retroactive social insurance. Some people, through no fault of their own, took a big hit from a risk that only a few people were paying attention to. In order to relieve those people’s suffering, we are giving them money that they can use to pay rent and buy necessities, as well as money to pay down debts so they have a bit more financial security.

Who is paying for this social insurance? In the case of paying rent and paying down debt, there’s no change in the economy’s use of real resources, so no one has to “pay”. This isn’t a free lunch — it’s simply people eating the same lunch they were before. They’re living in the same houses, eating the same food, etc. All we’ve done is reshuffle financial claims, altering the distribution of wealth. That will eventually change the distribution of real resources (see Emi Nakamura on that point), but not today.

BUT, in the case of people buying more actual stuff with their government checks — ordering more food and household goods on Amazon, for example — someone will have to pay. It could be that prices for food and Amazon goods rise, hurting the people who didn’t get the checks (and causing inflation to rise). Or it could be that a few idle resources really are put to work, in which case the relief checks partially act as a Keynesian stimulus, which doesn’t waste any resources, so no one pays. (It could also be that companies wear out their people and their machines producing more, in which case the economy as a whole will be a bit poorer down the road, so that future people pay. But let’s leave this aside for now.)

So basically, three things happen from the relief checks:

1. We redistribute wealth in response to an unexpected disaster (retroactive social insurance). This doesn’t cause much inflation or increase GDP much.

2. We put some idle resources to use (fiscal stimulus) and allow people to increase consumption. This increases GDP and prevents deflation.

3. We cause people to bid up the prices of consumer goods like food and Amazon merchandise without increasing production

Figuring out the risk of Biden’s relief bill requires predicting how much of the spending will go toward each of these three. Right now, folks like Blanchard and Larry Summers are discussing how much of (2) vs. how much of (3) there will be. But I think they’re basically ignoring (1).

I think that there will be a whole lot of (1). And I have data to back me up. An August 2020 paper by Olivier Coibion, Yuriy Gorodnichenko & Michael Weber found the following:

Using a large-scale survey of U.S. consumers, we study how the large one-time transfers to individuals from the CARES Act affected their consumption, saving and labor-supply decisions. Most respondents report that they primarily saved or paid down debts with their transfers, with only about 15 percent reporting that they mostly spent it. When providing a detailed breakdown of how they used their checks, individuals report having spent or planning to spend only around 40 percent of the total transfer on average. (emphasis mine)

This suggests that a majority of COVID relief spending goes to retroactive social insurance, not to fiscal stimulus. That means if you measure the multiplier for this spending, it’s going to be a lot lower than multipliers in traditional recessions like the Great Recession. But it also means that thinking about COVID spending in terms of “multipliers” really isn’t that useful, because empirical data on multipliers in past recessions just doesn’t apply here.

Instead of calling Biden’s bill “stimulus”, I think we need to emphasize that it’s more like disaster relief. It’s a way of pretending that everyone had a government-sponsored insurance policy against a once-in-a-century pandemic, back in February of 2020. COVID wasn’t fair, but our society can choose to be fair.

---