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A nation must think before it acts.
The COVID-19 pandemic has brought shortages of many things, from ventilators in hospitals to hand sanitizer on store shelves. Also in deficit is economic activity, as people are prevented from spending and working by stay-at-home orders. Tax revenue is in deficit, too, causing federal budget shortfalls of a scale not seen since World War II. Most states are in such dire financial straits that some politicians have even proposed letting them file for bankruptcy. At the federal level, the government budget deficit may be 17% of gross domestic product (GDP) in 2020, estimates the nonpartisan Congressional Budget Office (CBO), though it could well be higher. Deficits of consumption and production are guaranteed to produce deficits on the government’s balance sheet.
What of surpluses? The most obvious surplus is of deaths, caused by the virus. America’s Centers for Disease Control and Prevention (CDC) only collects mortality data with a long lag, so it is difficult to measure excess death in the United States. But in New York City, the center of America’s epidemic, three times as many people have died this spring than is normal—a surplus of over 20,000 deaths. The number is likely to keep growing for several weeks.
Excess deaths have come alongside excess debt. The CBO estimates that federal government debt will be 101% of GDP by the end of this year, and approaching 108% by the end of 2021. This is likely an underestimation because Congress will legislate additional relief programs as the crisis continues. The increase in government indebtedness under the Trump administration will be roughly equivalent as a share of GDP to the Obama administration’s crisis-fighting efforts after the 2008 crash. Under the Trump administration, the government was already running large deficits. Now, the deficit figures are shooting yet higher.
The United States is not alone in this vast increase of debt on the government’s balance sheet. Across advanced economies, governments are picking up the tab for spending where quarantined workers and consumers cannot. From France to Germany, the United Kingdom to Japan, governments are handing out cash to households, helping firms pay workers’ salaries, and guaranteeing debt so that companies can stay afloat.
To fund these vast deficits, governments are issuing bonds at a rate unprecedented since World War II. The private sector is gobbling up government debt, as investors dump other debt securities, fearing that the economic crash makes them too risky and seeking safe havens in government debt instead. As a result, interest rates that governments pay to borrow have fallen even as the amount they borrow has increased. That is not how interest rates normally work, but economic crises—and pandemics—are no normal times.
The U.S. Federal Reserve has said it could buy unlimited quantities of U.S. Treasuries (government bonds). Estimates suggest that the size of its balance sheet—i.e., the number of bonds it has bought—could double or almost triple over the course of the year. In addition, the Federal Reserve is also buying new types of assets in new ways. It has promised to buy $600 billion in loans to small- and medium-sized businesses and $500 billion in bonds issued by certain state and local governments—on top of existing programs such as buying bonds backed by mortgages. After the 2008 crisis, the Federal Reserve launched a series of programs called “quantitative easing”—essentially, bond purchases aiming to drive up asset prices and spur lending. Today, the Fed is on target to buy the same quantity of assets that it purchased in the decade after 2008—but now in several months rather than 10 years.
Economic theory suggests that when governments vastly expand their government debt burden and when central banks buy a portion of this new debt—thus pumping liquidity into the market place—the result can be inflation. In the United States, the Federal Reserve has created money to buy securities on the open market. In the UK, however, the central bank is printing money to lend directly to the government, with the government simply promising that it will someday repay the funds.
Economic history provides many examples of money printing causing runaway inflation. The logic is simple: if there is more money, but the same amount of goods, the ratio of money per good—the price—goes up. But reality is sometimes more complex. In Japan, the central bank has been buying government bonds for decades, to the extent that it now owns half the stock of government debt. Yet, it has failed to hit its meager target of 2% inflation for most of the past two decades.
Financial markets are currently betting that advanced economies are continuing along the path cut by Japan, coupling massive borrowing coinciding with low inflation. Perhaps, the next step will be formally tasking the Federal Reserve with controlling government borrowing costs, as Japan has done for several years and as the Federal Reserve did in World War II. In Japan, this has not produced any inflation. In the United States, after World War II, inflation shot upward, wiping out part of Americans’ savings in the process.
COVID-induced unemployment ought to make inflation less likely because consumer spending will fall. But disruptions to production coupled with social distancing measures may reduce the supply of goods available for purchase, too, which could have the effect of spurring inflation. We have deficits of spending and employment, but surpluses of income and debt. We understand roughly how normal economic slowdowns work—but usually recessions are involuntary and comparable shallow. The economic deep freeze underway is deeper than anything we have seen for decades, and entirely of our own choosing. That makes it hard to project what effect the vast increase in government borrowing will have—and difficult to assess who, ultimately, will pay the price.
The views expressed in this article are those of the author alone and do not necessarily reflect the position of the Foreign Policy Research Institute, a non-partisan organization that seeks to publish well-argued, policy-oriented articles on American foreign policy and national security priorities.