The COVID-19 Stimulus and the COVID-19 Recession

Published August 28, 2023

Did the fiscal and monetary policy responses to the COVID-19 economic shock — $5 trillion in spending and a $5 trillion increase in the Federal Reserve System’s balance sheet — prevent a worse recession? Economics takes up such challenging questions.

There are several related questions I will not consider here. Do the costs of inflation spurred by the COVID-19 stimulus outweigh any gain from a milder recession? How does the labor shortage worsened by generous unemployment benefits affect evaluation? Finally, did the “lockdown” policies even slow the spread of COVID-19? If not the costs of job losses and business closures were for naught.

What would have happened with the lockdowns but without the COVID stimulus measures? This involves constructing a counterfactual, or path of the economy we did not observe. Washington and the Federal Reserve acted aggressively, so we did not observe lockdowns with no stimulus, and we cannot conduct a replay to experiment.

Economists construct models to build internally consistent counterfactuals. We want realistic counterfactuals, given the proviso that we cannot verify predictions about a path the world did not travel. Economics is about envisioning paths we have not traveled.

Let’s start with the potential for fiscal and monetary policy to counter downturns in the main macroeconomic model. Macroeconomics views recessions as short run fluctuations around a long run equilibrium with steady economic growth. In this framework the economy eventually self-corrects. Fiscal and monetary policy can at best shorten or moderate a recession.

Supply and demand are the two sides of any economic market. Recessions occur due to fluctuations in aggregate demand or aggregate supply. Some recessions are supply shocks (1970s oil shocks) while others result from reduced aggregate demand.

Fiscal policy uses debt-financed government spending to increase aggregate demand. A monetary stimulus can increase aggregate demand through business investment or offset a credit-induced supply disruption. Monetary policy can also assist banks in distress to prevent a collapse of credit.

Macro models also offer reasons why fiscal and monetary policy may not work. One reason is lags in fiscal and monetary policy. A stimulus will not immediately boost economic activity, just like aspirin does not instantaneously relieve a headache. This can be offset through forecasting, but economic forecasting is imperfect. Government spending can also crowd out private spending and not boost demand while businesses might not borrow even if the Fed lowers interest rates.

Is stabilization policy effective? Economists do not agree.  Some see the depth of the Great Recession despite the American Recovery and Reinvestment Act and the Fed’s monetary response as demonstrating ineffectiveness. Others contend that the package was too small (about $800 billion).

Recovery from the COVID recession was quick and vigorous. The recession lasted just two months, the shortest on record. It took seven and a half years to eliminate the 5.5 percentage point increase in unemployment from the Great Recession. The 11.2 percentage point COVID increase in unemployment was erased by July 2022.

Does this mean the stimulus worked? CARES Act checks were largely saved and not spent. The Boston Fed argues that spring 2020 PPP payments went to the largest eligible businesses and saved few jobs. A paper by University of California’s Alan Auerbach and coauthors documents that government spending prevented job losses only in cities not under strict stay-at-home orders.

Fiscal policy normally increases consumer spending. During COVD, fiscal policy appears to have impacted supply directly.

I believe that COVID did not produce a recession as much as a shutdown. The appropriate comparison may be a resort community during the offseason. Economic activity craters, but everyone knows why and expects a recovery with the change of seasons. Relaxing lockdowns brought economic recovery.

The brief COVID recession does not yield many lessons about macro stabilization. Much CARES Act spending was probably not even a fiscal stimulus but rather compensation for the economic victims of lockdowns. We did not need trillions in Federal spending to end the COVID recession, just governments to allow commerce again.

Photo by hard money lender. Creative Commons Attribution 3.0.