US fiscal policy is significantly less stimulating to demand than it was in 2020-2021, when the government and Congress authorized over $5 trillion in deficit-funded spending to fight the pandemic. But the government continues to pump money into the economy and provide spending incentives. Fiscal policy therefore remains expansive.
Many budget funds have not yet been spent
In 2020 and 2021, US fiscal policy was extremely expansionary due to various spending programs. The vast majority of spending included in the March 2020 CARES Act ($2.3 trillion), the December 2021 Consolidated Appropriations Act ($0.9 trillion) and the March 2021 American Rescue Act ( $1.9 trillion) approved have already been spent. Most of this has taken the form of direct transfers to households and small businesses. However, a considerable part of the funds has not yet been spent and will therefore only flow into the economy in the future.
Most of the unspent funds are the $500 billion in state and local federal grants provided through the CARES Act and the American Rescue Act. The federal grants were supposed to be used for corona-related health expenditures, but this has not happened. The strong economic recovery has boosted tax revenues and run large surpluses – exactly the opposite of what had been predicted. The states and localities saved the federal grants. They held most of the funding in U.S. Treasuries, which have grown in size from $750 billion before the pandemic to $1.55 trillion in the third quarter of 2022. This increase corresponds to over 3% of GDP.
The increase in holdings of US Treasury bonds by states and local governments is very unlikely to be the result of a sustained increase in the need to save. Instead, the excess savings are likely to be spent over time and, in some cases, used for tax cuts. A part is already issued; for example, some states have distributed funds to citizens to offset the burden of high energy bills. That was not the aim of the COVID programs – but it is not unusual and ultimately to be expected that politicians reinterpret the rules. Subsequent use of these funds will boost the economy regardless of what happens to the federal government’s budget deficit. In a sense, it is the lagged effect of fiscal stimulus.
inflation effects
The increased cost of living leads to extensive adjustments for social security benefits. Such adjustments to programs including Medicare, Medicaid, and state pensions increase federal spending and disposable personal income. The 8.7 percent adjustment in Social Security benefits alone will cost more than $100 billion in 2023. The inflation compensation in other government programs exceeds this amount. While it compensates for the beneficiary’s inflation-related fall in real purchasing power in 2022, the total inflation adjustment will increase disposable income in 2023 by over 1% of total disposable income.
The adjustment applies not only to Social Security, but also to military retirees, civil service retirees, veterans’ pensions, and railroad retirees. The Congressional Budget Office (CBO) estimates government spending on federal civilian, military, and veterans retirement programs at $373 billion in fiscal 2022. A number of other inflation-indexed programs have benefits linked to increases in the food component of the consumer price index. Food prices have risen faster than the comprehensive consumer price index.
Also in the tax system, various components and provisions are adjusted to inflation. This limits tax increases and, for many households, reduces taxes withheld from income, increasing nominal net income.
Debt relief for students
Student debt forgiveness (and other forms of debt relief) increases disposable personal income, thereby encouraging the propensity to spend. Estimates of the amount of debt relief vary. But an approximate figure is $400 billion, which is about a quarter of all outstanding student debt.
Consumer Savings
Household savings soared in 2020 and 2021 as consumers saved a sizeable chunk of government income support paid in the wake of the pandemic. After the final transfers under the American Rescue Plan in March 2021, household savings were estimated to be $2.5 trillion above pre-pandemic levels. Since then, consumers have been spending an increasing part of their disposable income, which is reflected in the recently historically low savings rate of private households. However, the savings cushion is still about $1.25 trillion, or 6.6% of disposable personal income. These “excess savings” are likely to be used up over time, so the fiscal stimulus will have a delayed effect.
The government’s Corona aid was also a considerable support for small companies. Although it is difficult to track these transfer flows accurately, companies still hold large cash reserves. They will be spent in the future and thus stimulate the economy.
„Infrastructure and Jobs Act“
The 2021 Infrastructure and Jobs Act authorized $1.2 trillion in spending. This cost estimate is based on a 10-year budget projection. If the approved funds are spent, they will boost the economy and employment. Spending focuses on roads, bridges, transportation systems, public transport, electricity and clean air initiatives, urban renewal, expanded broadband access, cybersecurity and environmental remediation.
In contrast to government transfer payments, practically all infrastructure spending will include government investments that have a direct impact on GDP. Most jobs are likely to be created in the private sector (along with new government jobs created to manage the infrastructure initiatives). GDP will increase significantly. Assuming spending is spread evenly over 10 years, the $120 billion will add about 0.4% per year to GDP in the early years. It is important that experience has shown that the fiscal policy multipliers of government investment spending are far higher than government transfer payments.
Accurately tracking spending authorized through the Infrastructure and Jobs Act is very difficult. Despite government efforts at transparency, and despite the new government agencies created to implement and oversee infrastructure initiatives, there is no easy source of information on actual spending. Most likely, for political reasons, a larger proportion of the approved expenditure will be made in the early years.
„Inflation Reduction Act“
The Inflation Reduction Act provides tax credits to subsidize the purchase of clean energy products (electric vehicles, solar panels, etc.). It sets caps on certain prescription drugs, lowers the cost of certain health insurance plans, imposes minimum corporate taxes, and improves IRS tax collection for high-net-worth individuals. The CBO estimates that the energy- and climate-related tax credits will reduce tax revenues by $391 billion over the 10-year projection horizon, while health-care subsidies will cost $108 billion. In addition, the CBO estimates that these costs will be offset by savings in drug prices and higher tax revenues.
Overall, the fiscal measures should boost aggregate demand and partially cushion the impact of tighter monetary policy.
Longer-term projections
Since the CBO’s last fiscal projection in May 2022, inflation and interest rates have risen significantly more than the CBO forecast. As a result, budget deficits and government debt have risen above the CBO’s projections. Higher debt and interest costs will have an even greater impact on the CBO’s longer-term projections.
The CBO had projected consumer price inflation to average 6.1% in 2022 and 3.1% in 2023. Instead, consumer prices increased by 8.0% in 2022. The CBO expected the yield on 3-month Treasury bills to average 0.9% in 2022 and 2.0% in 2023. An average of 3.4% and 2.9% was expected for 10-year Treasuries. Instead, the 3-month Treasury bill averaged 2.0% in 2022 (3.5% in H2 2022) and the 10-year Treasury bill averaged 3% (3.5% in H2 2022).
In its May 2022 report, the CBO estimates that net interest costs will increase from $399 billion in 2022 (6.8% of total federal spending and 1.6% of GDP) to $1.19 trillion over ten years and increase thus doubling to 13.4% of total spending and 3.3% of GDP in 2032. The net interest cost is increasing in the longer-term projections and, along with Social Security, Medicare, and Medicaid, is the primary driver of spending and debt growth. The updated projections will be much higher as interest rates are higher than forecast. Even if interest rates flatten out at the CBO’s longer-term projections, higher interest rate levels to date will have an amplifying effect, further pushing up government debt-to-GDP ratios and debt-servicing costs.
The government debt ratio has doubled since the global financial crisis and is expected to continue to rise sharply. Government spending as a percentage of GDP will also increase sharply, primarily due to higher spending on various programs (Social Security, Medicare, Medicaid, and others). This reflects the aging of the population, higher real health care costs and rising net interest costs. Higher-than-expected inflation is driving up spending on Social Security, pensions, and other inflation-linked programs significantly. This increase will intensify. At the same time, the decline in real wages and tax adjustments limit the increase in tax revenues.
The risks of high and rising debt and interest rates are well known: risks of financial instability, higher interest rates and inflation, foreign demand for US Treasury bonds, restraints on government program spending, and negative impacts on growth. The list could be extended. These issues need to be closely examined and monitored. But there is little political interest in addressing the fundamental changes that would be needed to stabilize the debt ratio projections.
