Submitted by Joe Carson, former chief economist of AllianceBernstein
As Washington rushes to approve a fiscal aid package to cushion the economy from the coronavirus the critical question is how big of a fiscal response is needed. Drawing on the lessons of the Great Financial Recession Washington should consider linking the size of fiscal package to the potential decline in nominal GDP. Under various scenarios, a fiscal aid package of $3 trillion would be needed.
GDP Decline & Fiscal Aid Package
In late 2008, following the plunge in real and financial asset prices and the attendant-banking crisis, Washington faced an unprecedented collapse in economic activity and an increase in joblessness, with little foresight on how long both would continue.
The first policy response was legislation to help recapitalize the banking sector and stabilize the financial markets. The price tag of that legislation was $700 billion.
Washington then approved an economic stimulus bill to fill the “holes” that were being caused by the drop in economic activity and job loss.
A fiscal aid package of over $700 billion, was signed into law in February 2009, and included tax cuts, increased spending for unemployment benefits, education and health care along with large grants and loans to state and local governments to help spur spending on new infrastructure projects.
The economic stimulus package was helpful in providing support to people (employed and unemployed) and business activity. But, the economic decline continued for an additional five months, and the recession officially ended June 2009.
The final numbers for that era show an economy under severe stress. Nominal GDP declined $480 billion over a three quarter span, from Q4 2008 to Q2 2009, the first outright loss in nominal output since 1960. Also in Q4 2008, S&P 500 operating profits posted an outright decline, the only time in the post-war period an operating loss was reported for the largest US companies.
Comparing the fiscal support to the economic loss, there was $1.5 of fiscal aid for every $1 loss in nominal GDP. That does not include the $700 billion that was directed to the banking sector and financial markets.
The economic and financial fallout from coronavirus is more abrupt and severe than what occurred in 2008/09. Analysts now see GDP declining 5% to 10% (not annualized) over the first half of 2020. A decline at the low end of the range would represent the largest decline in the post war period, and the upper end would represent a decline more than twice that of 2008/09.
The scale of the potential economic loss is unprecedented . For example, at the end of 2019 Nominal GDP stood at $21.73 trillion, so under the aforementioned projections and assuming no inflation the loss of nominal output ranges from $1.1 to $2.2 trillion. And a record loss of nominal output also means an equally large loss in nominal income; in other words, record declines in wage and salary income and business profits.
Applying the $1.5 of fiscal aid to every $ 1 loss of nominal output---equivalent to that of the Great Financial Recession---suggests a fiscal aid package of $1.7 trillion to $3.3 trillion.
That package only fills the “holes” in the economy. However, small businesses also need financial aid, which given their scale could easily equal the $700 billion bank bailout bill. Together, that would result in a fiscal aid and financial support package of $2.4 to $4 trillion, with a mid-point range of around $3 trillion.
Uncertainty surrounding the economic projections as well as the scale of fiscal aid and financial support is very high, but its not any higher than it was in late 2008 or early 2009. Even with the unknown’s there are two takeaways for Washington.
First, the need to act fast is paramount. The speed and scope of change in the economic and business environment is unprecedented. At the beginning of March, talk of recession was non-existent and three weeks later the US faces the largest economic collapse in the post war period.
Second, the need to act “big” is essential. Substantial fiscal aid is needed to fill big “holes” in the economy. The scale of economic losses for individuals and businesses are so large and broad that if not filled quickly runs the risk of a “domino” effect.
In the end, Washington needs to approve a substantial fiscal and financial aid package that can in a short-time span stop the contraction in the economy, and stabilize public and business confidence. This will ensure that post recession there is a sufficient private business structure to generate jobs and overall growth.
A $3 trillion fiscal aid/financial support package is a minimum number.