Domestic Affairs

Foolproofing the Economy from the Next Recession

The unprecedented economic recession triggered by COVID-19 has highlighted the limits of the country’s legislative capacities. While the initial round of negotiations on an economic support bill went relatively smoothly, they have since stalled. House Democrats passed a bill in May, but talks on Senate Republicans’ answer in the “skinny” relief bill will not resume until after the election. Squabbles on Capitol Hill have no near end in sight even as more and more Americans continue to be evicted, lose jobs, and put their entire lives on hold. Some, remembering the 2008 recession, may see the latest impasse as just another certainty in American politics, but the truth is that it doesn’t have to be this way. 

There are a host of reasons why our current method of handling recessions is not working as well as it could. The first, and the one you most likely learned in your introductory economics class, is that government fiscal policy quite simply takes time. The very nature of a liberal democratic society requires our elected officials to have long drawn out discourses over which is the best course of action in any given scenario. Unfortunately, during a global pandemic and a generation-defining recession, time is a luxury the nation cannot afford. As a result, the intermediary period between the initial economic crisis and a bill finally getting passed leads a lot of people to suffer. 

More nefarious reasoning will probably continue to impede any further economic aid in the weeks to come in this particular instance as well. Some Republicans have already foregone a Trump victory in November and seem to be positioning themselves for a re-election platform in a post-Trump world. Republicans like Sens. Ted Cruz (TX) and Rand Paul (KY) have denounced further government spending and seem unlikely to go along peacefully with further negotiations. History proves there is indeed precedent for many Republicans to turn fiscally conservative after an economic crisis. During the Great Recession, Republicans found themselves opposing relief with the greatest fiscally conservative advocates coalescing to form the Tea Party. Republicans fearing a Biden victory may continue to fight any new economic relief aid in the Senate and therefore hold up any progress in the foreseeable future. 

The financial impacts of COVID-19 will almost certainly still be felt next year. Although many legislators have insisted our current economic slump will be V-shaped, that seems unlikely to be true. Small businesses, although on the decline, still make up a considerable portion of the American economy and are struggling the most. As many as 110,000 small businesses have already permanently closed due to the pandemic and related shutdown policies. The hundreds of thousands out of work will mean reduced consumption and, therefore, reduced revenue for other businesses initiating a vicious cycle, which characterizes a recession. With the pandemic showing no sign of slowing down, it is becoming clear that we will be dealing with its repercussions for years to come. As dire as the situation may seem, there are some methods for alleviation. For instance, automatic economic stabilizers provide an out to a seemingly insurmountable obstruction.

In short, stabilizers release government support into the economy as soon as there are signs of a catastrophe rather than afterward. General economic knowledge holds that taxes increase during periods of growth so that spending can increase during recessions and soften the blow. Status quo stabilizers include unemployment insurance and other similar methods of government relief but are nowhere near as ambitious as is needed. A study published in the Journal of Public Science analyzed the effects of automatic stabilizers in the U.S. and Europe and found that Europe’s model had absorbed nearly 50% of unemployment shocks during the 2008 global recession. In comparison, the U.S. model had been able to absorb only about 34%. In this case, to absorb a shock refers to as closely as possible matching the average income of someone who is unemployed compared to their income when they were employed. 

It is important to note that the European system of stabilizers is far more robust than the American one, explaining the differences in the results. Not only is the EU model far more generous, but it also works at a quicker pace and encompasses more people. Economic shocks can take shape in other ways as well, such as income shocks or demand shocks. Still, the results remained the same across the board: stabilizers cushioned the blow, and Europe, with its more robust system, was able to weather the storm more effectively than the United States. Recovery, on average, was smoother, and impacts on individuals were less harsh. If implemented successfully, an automatic stimulus can help drastically reduce the impact of an economic downturn.

There are two primary forms of automatic stabilizer effects relevant at this current moment: “hard” effects and “soft” effects. Understanding both is paramount to determining the merits of automatic stabilizers.

Long term stabilizers would use specific bellwether indicators as a metric upon which to condition the release of aid. For example, as soon as unemployment claims start getting a bit too high or the stock market begins to dip, the government would start sending stimulus checks, forgiving loans, and/or giving tax incentives. Any policy which includes such ambitious goals would most certainly require quite a bit of political capital to get passed, but the results may just make it worthwhile. 

The positives are easy to see and understand. For one, there are hard effects, a result of material government efforts. Increased government spending is a surefire way to boost the economy during a recession and is what is most likely to happen in the majority of all dips regardless. It only makes sense to front end the blunt policies we know will likely get passed anyway during a recession and leave Congress to work out the rest of the specifics in the intervening time. 

On the other hand, there are relevant soft effects as well. Soft effects are a result of the knowledge that the government will take future action. As the stock market crash of March 2020 proved, much of our economy is driven by how we feel about it. When we feel overly cautious, consumer spending goes down, brokers sell their stock, and overall, the economy suffers. Wall Street, preempting a lackluster COVID-19 response, reacted by dropping over 3,000 points overnight, causing the loss of retirement savings, reduced investment, and general instability throughout the country. 

Stabilizers can provide a sense of security to those in Wall Street, as well as to the average consumer. If you know that you will receive a government check if you lose your job to the recession, you are much more likely to not slash your spending habits at the first sign of economic trouble. The same principle applies to the stock market. A sense of security prevents the vicious cycle described earlier and can restrain the worst of the recession from spreading. 

In the short term, Democrats would also be wise to look toward automatic stabilizers. A Trump victory would almost certainly mean no additional packages like the CARES act would see the light of day. The Trump administration has shown little interest in instituting any serious policy to deal with COVID-19. A victory at the polls in November will only serve as a reaffirmation of his current strategy. On the other hand, if Biden manages to secure a win, the prospects are not much brighter. Anything short of a Democratic supermajority in the Senate will mean finite political capital will have to be spent to shore up support for a costly relief bill with a price tag in the trillions. At the same time, the administration will be grappling with racial injustice, controlling a pandemic, and reversing Trump-era policies. 

However, if Congress can pass legislation targeting key economic indicators rather than dates as endpoints for aid, it would ensure that a shift or a lack of one in presidential administrations doesn’t mean more suffering for American families. Therefore, it would be in the best interest of all parties involved to look toward stabilizers as a possible pathway toward less variability in recessions and quicker response times when they do occur. Republicans facing re-election as the ruling party would be wise to run on a stable economy and Democrats should seize their current leverage to ensure the economy doesn’t get much worse before it gets better.

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