As we approach the expiration of various provisions in the CARES Act intended to help keep millions of Americans afloat during the recession, Congress proceeds with its bipartisan back-and-forth as to what should be in the next stimulus bill. One thing I noticed missing in this round of negotiations was the one-time $1,200 stimulus checks for individuals ($2,400 for married couples). This was unusual considering how much President Trump was clamoring for it earlier this year. Rather than delve into the politics, I prefer to examine the policy aspect.
The premise behind a stimulus check is based in Keynesian economic theory. Essentially, the government sends its populace money. That money burns a hole in their pockets, so to speak. The increase in disposable income is sent to incentivize consumption, which in turn drives revenue increases at retailers, manufacturers, and other establishments. Ultimately, the stimulus checks are to translate into an economic boost. There was a secondary reason of keeping people isolated with the hopes that the pandemic would have short-term effects, but that clearly did not pan out.
I could say there were some advantages to sending stimulus checks to people directly. One is that the process was relatively simple. If you as an individual made $75,000 or less in adjusted gross income in 2018, you received a check in the full amount. There were not income brackets or tax exemptions, which made the IRS' processing straightforward (even if imperfect). Second, because of its simple processing system, many people were able to receive the checks relatively quickly. Third, as the Peter G. Peterson Foundation mentions, the payments did go to those most financially hurt by the pandemic (see below).
This brings me to the complaints I have about the stimulus check program. Some of those complaints are specific to the particular implementation of the last round of stimulus checks. I could complain that it was not well targeted, given the eligibility ceiling of $75,000. However, that could be rectified by changing the eligibility requirements to make sure that the funds reach those who need the money the most.
Another complaint is with regards to improper payments. According to the Government Accountability Office (GAO), nearly $1.4 billion of those stimulus check payments (or 0.5 percent of the $292 billion spent) went to deceased individuals. The GAO discusses in its report how the IRS can improve the hypothetical next round of stimulus payments.
My issues with the stimulus checks go beyond the implementation. As University of Chicago professor Constantine Yannelis points out, the stimulus checks do not distinguish between households and recipients, which means that it ends up being poorly targeted in terms of who needs it the most (unless you severely limited the eligibility requirements). The same thing happens with minimum wage. Because minimum wage is based on individual income (as opposed to household income), it helps out a disproportionately small percent of lower-income households. This phenomenon would explain why Yannelis calls the stimulus checks a blunt instrument.
An even bigger point is this: if one of the main goals of stimulus checks is to spur consumption, what we should see is that most, if not all, of the stimulus payments went towards consumption. So how were the stimulus checks used? The Federal Reserve Bank of New York found that 25.9 percent of households used stimulus checks for consumer spending.
The biggest use of those stimulus checks were savings (36.4%), followed by paying off debts (34.5%). This means that the majority of the stimulus checks did not go towards consumption. A study from economists at the University of Texas, University of California-Berkley, and the University of Chicago had similar results (Coibion et al., 2020). Not only did these economists find that only 15 percent of households spend, those who did spend only used 40 percent of the check on average to spend. Those who were more likely to spend were those without work, lived in larger households, faced liquidity issues, and/or were less educated.
The fact that the stimulus checks fail at one of its most basic goals does not surprise me. I take a look at the Great Recession, the only other time in U.S. history where we really had this magnitude of stimulus checks, and see what happened. An economist at Stanford University not only found that the 2008 stimulus checks did little to boost aggregate demand, but also that consumption proceeded to decline in proceeding months (Taylor, 2018). Cash for Clunkers, which was a similar indirect transfer program during the Great Recession, shows similar failures in boosting long-term consumption (Hoekstra et al., 2014; Gayer and Parker, 2013).
And then there's the research on stimulus more generally. An economist at the University of California-San Diego investigated the effectiveness of government spending in response to recessions (Ramey, 2018). She concluded that the multiplier effect typically ranges between 0.6 and 1.0 (see graph below), or in layman's terms: government stimulus spending in response to recessions typically remains ineffective.
To make the matter worse, a high debt-to-GDP ratio erodes the multiplier effect even further. This is important considering that the United States' debt-to-GDP ratio is expected to reach 98 by the end of the year (Congressional Budget Office). Some other countries have had a zero multiplier effect (e.g., Huidrom et al., 2019; Auerbach and Gordonichenko, 2012) where as some countries have been found to have had a negative multiplier effect (e.g., Ilzetzki et al., 2012). Why is this the case? Because when a country faces a high level of debt and spend a lot, a fiscal contraction is pending to compensate for managing the debts. Since such adjustments are anticipated, there have been times where the short-term consumption gets largely offset. Macroeconomically speaking, what we see is that government stimulus does not produce desired multiplier effects and that more specifically, stimulus checks do not produce the desired boom in consumption.
Postscript
Thankfully, there is light at the end of the tunnel. The findings with the Pfizer and Moderna vaccines are quite encouraging. The United Kingdom already approved an emergency use authorization for the Pfizer vaccine. If all goes accordingly, it looks like we can start head back to normalcy around mid-2021. In the meantime, we have another six to seven months to go. We need something to hold us over in the meantime, and direct stimulus checks do not seem to do the trick. It is not simply for the multiple, aforementioned reasons.
While there is a demand shock component to this recession, there is also a major supply shock element, which is contrary to past recessions that have primarily been due to demand-side shocks. Even assuming the shocks to supply and demand are equal, there is nothing that stimulus checks can do to mitigate the supply shock. To help with the supply shock, businesses need the equipment to operate safely. What else would help is widespread testing, which is something I have said since early April. Making sure that businesses have personal protective equipment and have the support to implement proper safety measures is what we need. I won't say that another round of stimulus checks is like flushing money down the toilet, but it is safe to say that there are better ways we could spend and target money to get through the rest of this ordeal.
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