The US government is set to pump US$70 billion into the economy through business and child tax credit if congress passes the legislation for the stimulus. The government’s rationale is that the stimulus will boost household and business consumption, which can ably support growth and reduce a technical recession risk. Republicans in the parliament are opposed to this initiative on the back of the government shutdown which has threatened the fiscal coffers. Given that the fiscal shutdown is influenced by fiscal deficits, the lawmakers are of the opinion that a fiscal stimulus will trigger multiple episodes of fiscal shutdowns. Another contrarian stance to the proposed fiscal stimulus is US Fed plan to launch its dovish campaign. Analysts are of the view that the US Fed will cut interest rate by 25bps each on two occasions. A fiscal stimulus, which will boost household spending, is re-inflationary and is likely to derail the course of the planned accommodative monetary policy.
Should the US government proceed with this fiscal stimulus? This is the question bothering on the mind of analysts and while there are different perspectives on this issue; we can focus on the appropriateness of the timing and the magnitude of the fiscal stimulus.
Is US$70 billion sizable enough to affect economic fundamentals in the US economy? Let’s consider inflation first. Using US monthly data point on inflation and broad money supply from January 2000 to December 2023, and estimating a simple regression model, the marginal impact of broad money supply on headline inflation in the US is 0.12. This simple estimation suggests that if the entire US$70 billion hits broad money supply, inflation will increase by 0.01 percentage points. So clearly, the impact is insignificant. This finding is reasonable given that the US broad money supply at the last reported date of November 2023 is put at US$20.77 trillion. US$70 billion represents only 0.34% of the money supply stock. It is also important to note two assumptions in this analysis. first, that the entire US$70 billion hits the broad money supply, which is an extreme assumption; and second, that the injection hits the broad money supply all at once, which is not the usual pattern.
The insignificance of the proposed fiscal stimulus is also justifiable based on historical precedence. The ballooning of inflation in the US started after the lagged impact of the stimulus during the pandemic. The total COVID-19 stimulus in the US is arguably around US$5.6 trillion and an intervention of that magnitude was enough to push inflation to a new height of 9.1% in June 2022. US$70 billion is a small fraction of US$5.6 trillion; hence, the inflationary impact will be quite trivial.
From an economic growth perspective, we can equally prove that the impact of a US$70 billion fiscal injection will be insignificant on growth. Again, repeating the estimation of a simple linear regression model, we obtain a slope coefficient of 0.13, which means that the US$70 billion, if pumped directly into broad money supply, will increase economic growth by 0.01 percentage points. This is insignificant.
Considering these simple quantifications, it is clear that the impact of the proposed injection is not enough weight to move the muscles of inflation and economic growth. By extension, the US Fed will not likely cringe because of this move.
Having established that the magnitude of the proposed fiscal stimulus is not significant, we can turn our discussion to whether the timing is right. The US economic environment is currently laden with a snail-paced disinflation and weak economic growth. The US Fed has signalled a switch to a fed-put stance in 2024, with analysts expecting a total 50bps cut. While it is theoretically true that a fresh fiscal stimulus could nick inflation up; it is equally believed that this could spur economic growth. Defining when is a good timing will then depend on if the US Fed is more bothered about sticky inflation or recession fears. In my view, it is more of the latter than the former. This is because further hikes in interest rates can dampen aggregate output so much that it amplifies a demand-pull inflation. It is my opinion that the natural rate of interest has found a new level beyond the 2% campaign of the Fed. Hence, hiking interest rates may cause more harm than good to the US economy.
With the bright sides of this injection explained above, it is important to ask where this money would come from – federal reserves, public borrowings via bonds, or higher taxes. Whichever the case, it would create a different narrative on the overall impact of this fiscal stimulus.
Written by Michael Ogunremi
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