Why the next president can’t credit stimulus for the booming economy

Last year, the U.S. economy grew at a faster rate than any other large, advanced economy. It looks like it will do so again this year. 

This strong performance leads some economists to credit the Biden administration’s large fiscal stimulus policies. But with the national debt now over $35 trillion, hopefully, either a Harris or a Trump administration recognizes that this is a misleading analysis.

Crediting fiscal stimulus for the current economy misses two crucial points. First, it understates the role of monetary policy since 2020. Second, monetary policy is much less costly to taxpayers than fiscal policy, so it’s a much better tool for managing business cycles.

Some commentators think of monetary and fiscal policy as more or less equivalent tools in stabilizing total demand in the economy. Indeed, both policies were very expansionary — seeking to maximize demand and growth — during the COVID-19 pandemic.

However, there are critical differences. Fiscal stimulus entails redistributing money already in circulation from one part of the economy to another, either through taxation or, more commonly, borrowing. This borrowing adds to the national debt. 

In contrast, when the Fed pursues an expansionary monetary policy, it buys financial assets to introduce newly created money into the economy. Although excessive monetary stimulus is problematic because it creates inflation, it does not necessarily add to the national debt. Typically, money creation even reduces the debt, because it’s a form of tax revenue called "seignorage."

To be sure, the 2020 recession was an unusual event in which some fiscal expansion was justified. Major segments of the economy were shut down, so it made sense to provide fiscal relief early on and spend on projects directly related to combatting the pandemic. However, by the end of that year, it was clear that the economy would soon largely reopen.

Despite this progress, President Biden signed the $1.9 trillion American Rescue Plan in March 2021, just two months after President Trump had signed a $900 billion stimulus bill. As a result, millions of people received generous stimulus checks despite having never lost work. 

The American Rescue Plan also gave state and local governments $350 billion despite their only having experienced budget shortfalls of $60 billion at that time. Even some progressive economists warned that the stimulus was wildly excessive.

Proponents of this loose fiscal policy argue that the benefits outweigh the costs, pointing to our strong recovery from the recession. However, these benefits could have been realized just as easily with a tighter fiscal policy, as long as monetary policy remained sufficiently accommodative. 

It’s easy to imagine a counterfactual where the American Rescue Plan was smaller but the Fed had its foot on the gas pedal longer to ensure a robust recovery. With fewer stimulus dollars circulating, this approach arguably would have led to less inflation, too.

This is not to say the Fed’s performance has been perfect or that monetary policy has had no cost to taxpayers. The Fed earns interest from the assets it buys (like the Treasury bonds and mortgage-backed securities it purchased during the pandemic), but it also pays banks to hold reserves in its accounts. 

After initially dismissing inflation as “transitory” in 2021, the Fed repeatedly raised the interest rate it pays banks to keep money out of circulation, cool down the economy, and bring down inflation. The interest paid to banks began to far exceed interest from the Fed’s portfolio. One study by my organization, the Mercatus Center at George Mason University, put the cost to taxpayers at $1 trillion over a decade. 

Nevertheless, this is far less than the cumulative $4.6 trillion spent by the federal government in response to the pandemic.

Even before the pandemic, the U.S. was on an unsustainable fiscal path. The federal debt-to-GDP ratio had crept up above 100 percent in the late 2010s and had been expected to keep growing. The massive spending bills, coupled with the rise of interest rates, have dramatically worsened this problem.

Now, more taxpayer dollars than ever must go just to pay interest on the federal debt. Spending on interest is already expected to exceed defense spending this year and Medicare spending by 2028. By 2042, it is expected to exceed Social Security spending and become the single largest federal expenditure.

Put differently, the fiscal profligacy of the last several years will soon make it very difficult to fund our military and popular entitlement programs.

According to economics textbooks, policymakers should run budget deficits during recessions and surpluses during economic expansions. While that idea makes sense on a blackboard, our elected leaders have failed to live up to this ideal. Although the Fed is also not perfect, it has a much better track record at adjusting monetary policy in response to business cycles than Congress and the White House have at using fiscal policy.

Fiscal policy should be aimed at providing core government functions like defense, infrastructure and the social safety net. Leave stimulus to the Fed.

Patrick Horan is a research fellow at the Mercatus Center at George Mason University.