The United States: A Comprehensive Look At Their Monetary and Fiscal Policy in Light of COVID-19

When COVID-19 started to spread around the United States, Americans began to understand the extremity of the pandemic that awaited, and the federal government implemented public health policies that would help prevent the ongoing spread of the virus. Amid the struggle to contain the virus, there was undoubtedly a drastic change in the economy of the United States. As more and more individuals practiced social distancing and became more conscious of their day-to-day endeavors, economic activity in the United States ground to a halt, especially in facets of the economy like the restaurant industry. Thus, having undergone expansion for 128 months since 2009, the American economy went into recession in February of 2020 and experienced a drastic economic downturn for several months. In the first half of 2020, the economy suffered significant drops in real GDP, with the United States facing a 5% decrease in this regard during the first quarter of the year, and a 31.4% decrease in the second quarter of the year, according to the US Bureau of Economic Analysis. Meanwhile, the unemployment rate reached an all-time high of 14.8% in April of 2020. Moreover, beginning in early March, financial markets started to lack liquidity and stability. Additionally, investors faced uncertainty and opted against taking risks, with S&P 500 reaching an intra-day low on March 23 and decreasing 34% from its previous peak. 

Several policies have been implemented in the last year to combat the economic downturn brought about by the novel coronavirus. For example, The Federal Reserve has utilized active monetary policy, altering money supply and interest rates. Simultaneously, under two different administrations, the federal government has continued to implement fiscal policy, ultimately to facilitate the economic recovery of the United States from the shock of COVID-19. In analyzing the state of the economy with the implementation of such policies, several economic indicators will be used, three of which have already been mentioned: the unemployment rate, real GDP, and S&P 500. The unemployment rate, representing the proportion of the labor force that is unemployed, will be used to analyze the level of economic activity in the United States, along with the aforementioned real GDP, which measures the value of goods and services produced in the United States in a year, adjusted for inflation. S&P 500, an economic indicator that revolves around the performance of 500 leading companies in the US and reflects the stock market’s condition, will provide another diverse perspective into the health of the American economy. In addition, the CPI, the consumer price index, which measures the prices of goods and services found in a market basket purchased by a typical American family, will also be utilized to consider price level and inflation.

Since the substantial economic effects of COVID-19 became apparent in the early periods of 2020, the Federal Reserve has continued to execute assertive monetary policy, impacting money supply and interest rates to support the United States’ attempts at eliminating the recessionary gap.  On March 15, 2020, the Fed decreased the federal funds rate down to between 0 and 0.25 percent and lowered the discount rate at which emergency lending occurred to banks, moving it down to 0.25%. By decreasing and maintaining these two low-interest rates through 2021, the Fed has attempted to increase the money supply and promote the borrowing of money by consumers and firms. Theoretically speaking, such changes should lead to increases in consumer and investment spending with more money in the hands of consumers and firms. This would ultimately push aggregate demand up, thereby lifting the American economy out of the recessionary gap. Moreover, on March 15, 2020, the Fed also decreased the reserve requirement to 0. Once again, such a policy was likely implemented to increase lending by banks and boost overall spending. However, many critics have discussed how this policy has not been effective. This is because banks’ reserves have increased with the new reserve requirement, possibly due to insubstantial borrowing by consumers and firms. This means that the lower required reserve ratio likely had no meaningful effect on the spending in the economy, with this policy solely resulting in the stockpiling of excess reserves. Furthermore, in the last year, the Fed has consistently executed quantitative easing, buying $700 billion in government bonds and mortgage-backed securities to increase the money supply in the United States and encourage spending by consumers and firms.

All in all, analysts like Daniel Bachman, a senior manager at Deloitte, believe that this aggressive, diverse approach of the Fed in combating the economic implications of COVID-19 has helped to stabilize the economy and promote GDP growth.  Although the active policies of the Fed have undeniably contributed to helping the American economy, many suggest that COVID-19 has revealed the limitations of monetary policy in changing the state of the economy. Even with the proactive approach, the Fed has taken, it seems as though monetary policy in itself has not been enough to steer the economy. Critics have discussed how, because of the already low-interest rates in the United States, it will become more and more challenging to utilize a decrease in interest rates to promote spending and increase aggregate demand. This is particularly true given that negative interest rates are not economically viable and quite unpredictable. With the true impact of the Federal Reserve’s monetary policy being a subject of concern, the federal government’s fiscal policy has largely been seen as the primary tool to keep the American economy afloat through COVID-19.

The federal government has utilized many fiscal policy changes to increase aggregate demand and return the economy to pre-COVID levels, both under President Trump’s administration and President Biden’s administration. At the onset of the COVID-19 pandemic, when the American economy dipped substantially in its output and unemployment levels were skyrocketing, President Trump signed the CARES act on March 27, 2020,  a $2 trillion relief bill. It constituted a one-time payment of $1200 to Americans earning less than $99,000 a year and increased unemployment benefits for the many that had lost their jobs.  Trump only signed the second fiscal policy to combat COVID-19 after several months of political debate in Capitol Hill in late December 2020. This time, the federal government issued $600 stimulus payments to low-income individuals making less than 75,000 dollars and enhanced unemployment benefits to the jobless by $300 as part of a $900 billion relief bill. 

After President Biden was elected into office in January of 2021, his administration quickly implemented the third significant fiscal policy change to bring the economy out of recession. On February 5, 2021, Biden signed the American Rescue Plan Act, which included $1400 stimulus checks on low-income individuals and further extended the unemployment benefits to September 2021.  The premise of all of the previously mentioned fiscal policies was quite similar. The intended outcome was that, by injecting money into the economy and putting that money into the hands of the poor, the federal government sought to increase spending by consumers. The above policies were generally directed towards the less wealthy. The rationale is that poorer individuals tend to have higher marginal propensities to consume, constituting a greater spending multiplier and allowing the fiscal policy change to be more effective in shifting aggregate demand.

Although the federal government’s fiscal policies have catalyzed the recovery of the American economy in the latter part of 2020 through to 2021,  analysts have pointed out some pitfalls with these policies. According to a study conducted by the National Bureau of Economic Research, only 15% of Americans who received the stimulus check for the CARES act spent most of the transfer payment. In comparison, 33% of Americans incorporated in the program chose to save most of this money. With this relatively high proportion of individuals choosing not to spend the money from the stimulus check, this undoubtedly led to a lower than anticipated increase in consumer spending. As previously stated, the success of the three stimulus bills implemented by the federal government all hinged on the spending of the individuals who received the stimulus payments. Thus, the CARES act was likely slightly underwhelming in its ability to stimulate the American economy, given that hundreds of billions were spent on these transfer payments, with the CARES act likely resulting in a lower than expected change in aggregate demand. According to analysts, the same issues have also been seen with President Biden’s newly signed American Rescue Plan Act, which has similarly had an inadequate stimulative effect relative to the copious amounts of money spent.  Analysts have attributed this issue to the federal government being ineffective in targeting the stimulus checks in both cases. They have outlined how the federal government has failed to direct the payments towards individuals who genuinely need the money to sustain their everyday lives. 

Furthermore, as the government has undergone deficit spending to fund the unemployment benefits and stimulus check, analysts have pointed out how the fiscal policies could have an everlasting impact on the government debt. In making this point, they have often pointed to predictions that the debt-to-GDP ratio is set to increase to 110% by 2020. The same metric was measured at 79% at the end of 2019 before the pandemic, according to the US Congressional Budget Office. One of the worries often associated with government deficit spending is crowding out, where government borrowing leads to an increase in the demand for loanable funds, which ultimately causes a decrease in investment spending by firms due to higher interest rates in the loanable funds market. However, given the near-zero interest rates resulting from the monetary policy by the Fed, this crowding out will likely be insubstantial, at least in the short-run, as the interest rates will remain relatively low and have no drastic effect on investment spending. On the other hand, this increase in government debt will likely have more severe consequences for the American economy in the long run. Eventually, to erase this budget deficit, the federal government will have to implement a comprehensive contractionary policy, constituting decreased spending or increased revenue through tax payments. This ultimately means that the government’s ability to utilize expansionary fiscal policy in the future to combat any economic downturns will always be compromised by the need to pay off the large sums of debt. Also, whether or not interest rates are eventually pushed up so much that they lead to significant crowding out is still something of concern, given that the American economy has gone further and further into debt. 

Aside from this budget deficit concern, many have also questioned whether or not such drastic attempts at increasing aggregate demand could ultimately trigger growing inflation in the United States in the near future. This concept was especially prevalent after Biden signed the $1.9 trillion relief bill, with some analysts deeming the enormous volume of this bill excessive and quite risky. Larry Summers, a famed American economist, has been fervent in voicing this opinion, stating that the size of the bill is three times larger than necessary to close the remaining recessionary gap between actual output and potential output of $20 billion a month. Consequently, there is a risk of skyrocketing inflationary expectations and the destabilization of the dollar in the future. 

To consider how the federal government’s fiscal policies have changed inflation through 2020 and 2021 thus far, the CPI inflation rate can be analyzed using data from Alberto Cavallo of Harvard University. In January of 2020, before COVID-19 began to affect the American economy, the CPI inflation rate was 2.47%. As the United States experienced an economic downturn in the first half of 2020, the CPI inflation rate consistently decreased drastically down to 0.13% in May 2020. Since then, the CPI inflation rate has steadily increased into 2021, with the current CPI inflation rate at 2.67%. Thus, at present, there does not seem to be any excessive inflation in the economy. Inflation levels have returned to near pre-COVID levels, which reflects the recovery of the economy in closing the recessionary gap. Necessary aggregate demand increases have been brought about by fiscal and monetary policies to increase real GDP, and increased inflation has been a consequence. Nonetheless, suppose the CPI inflation rate continues to grow well into 2021 and 2022, with the repercussions of President Biden’s massive bill still yet to set in. In that case, the American economy could very well experience excessive inflation and financial instability in the coming years. 

So, analyzing the actions of the United States in response to the COVID-19 pandemic, it is apparent that the monetary and fiscal policies implemented were quite successful in stabilizing the American economy and helping it recover from the initial economic shock. 

This success is reflected by a decrease in the unemployment rate and an increase in the real GDP of the American economy since the second quarter of 2020. In the third quarter of 2020, real GDP grew by an annual rate of 33.4%, and in the fourth quarter of 2020, real GDP grew by an annual rate of 4.3%, according to the US Bureau of Economic Analysis. This is a testament to the extensive expansionary monetary and fiscal policies that the federal government and the federal reserve committed to in March 2020. Although real GDP still decreased by 3.5% in 2020 as a whole, the American economy is projected to continue expanding in 2021, especially with the $1.9 trillion relief bill signed by Biden, which will likely change aggregate demand quite dramatically. Meanwhile, according to the Congressional Research Service, after the unemployment rate in the United States reached a peak of 14.8% in April of 2020, it experienced a sharp decline in the latter part of 2020, ultimately decreasing down to 6.7% in December of 2020. In the first few months of 2021, the rate has continued to decline, with the rate currently at 6% in April 2021. Once again, this decrease in the unemployment rate reflects the recovery of the American economy from the initial economic downturn in 2020, as the unemployment of an economy directly provides insight into an economy’s production and its health. Thus, looking at this data reflecting economic activity in the United States, it seems as though the US government has been quite successful in limiting the economic impact of COVID-19 and eliminating the recessionary gap. Even though the American economy is still producing at levels under potential output and the unemployment rate of six percent is still significantly more than the unemployment rates in the US before COVID-19, the United States government made strides towards returning the economy to ‘long-run equilibrium’. Thus, it is likely only a matter of time before these issues are resolved. 

Furthermore, the economic rebound of the United States has also been evident in the stock market. After reaching an intraday low in March of 2020, the stock market steadily increased in the latter part of 2020, and the S&P 500 grew by 16.3% in 2020. This was despite the negative economic impact of COVID-19.  In the first few months of 2021, the stock market has hit an all-time high in its activity, with the S&P 500 constantly closing at record highs. Thus, if only the S&P 500 were utilized to analyze the economy, it would seem as though American economic activity had already returned to pre-COVID levels, and businesses were thriving as a whole.  However, given that other indicators like real GDP and unemployment point out that there is still a way to go for full economic recovery, one must acknowledge that stock market indices like S&P 500 have limitations in their ability to reflect the economy’s condition as a whole. While the stock market does generally reflect the performance of companies, many economists have continually discussed how there is a divide between the state of the economy and the stock market, with the stock market often most reflective of investors’ optimism rather than reality. In the context of COVID-19, analysts have emphasized how many small businesses – who have been most hard-hit by the coronavirus –  do not trade on the stock market and are not represented in any stock market indices. Furthermore, reputable analysts from sources including CNBC have explained that the recovery of a few large companies in thriving sectors like technology has contributed to the high S&P 500 values. In doing so, they have masked the fact that many companies are still struggling to recover from the coronavirus, with more than 50% of stocks still posting losses at the end of 2020. Thus, the record high S&P 500 values in 2021 likely over exaggerate the recovery that the American economy has been able to experience, even though the other economic indicators discussed do point to a positive trend in the American economy. 

Thus, it is clear that the United States economy has been steadily recovering in the last year due to the monetary and fiscal policies. Nonetheless, there has undeniably been room for improvement in the policies implemented by both the Federal Reserve and the federal government. As many of the issues surrounding these policies concern the American economy in the long run, a complete judgement of these policies is still impossible. Whether or not the fiscal policies were overly inflationary and brought about too much government debt. Whether or not monetary policies will continue to be a deciding factor for the economy will only be answered with time. Regardless, the American economy seems to be well on its way to returning to potential GDP and experiencing economic stability at pre-COVID levels of activity.