Asymmetric Inflation

America is on the road to recovery. Fiscal and monetary stimulus is brewing a magnanimous concoction to lift the economy. While the stimulus ingredients are similar around the world, the paths are diverging. This outcome reflects the policy choices made a year ago in America, which pre-funded vaccine development for preferential access. Most of the world lags America in distribution because of their position in the vaccine queue, not their policy response. The result is a multi-speed global recovery that will have the modest benefit of different leaders at different times that reduces the variability of global growth.The greater challenge is diminished growth in the long-term as tax increases and debt service crowd out other fiscal programs. Fortunately, America faces this global challenge with higher growth prospects as the Millennial generation workforce proportion increases. Carpe diem.

Rapid enactment of the American Recovery Plan has brought growth forward from the second and third quarters. The summer travel season may be the best quarter in a generation.

The balloon is inflating. In response to one of the most sudden and catastrophic economic events in a century, governments worldwide flooded the world with fiscal and monetary stimulus. The Pandemic required a material response. While the US sits on the cusp of normalcy as the vaccine’s distribution pushes forward, consumption growth reaches unheard of levels despite unemployment levels reminiscent of the Great Recession. This economic contrast highlights the uneven policy response that is magnifying one of the secular trends of the times: inequality.

The US is on the vanguard of the recovery, which is evident in the recent GDP data (exhibit 1). While consumption and investment recovered their losses from last year, exports continue to drag. The latter point highlights that the recovery is primarily an American phenomenon, not a global one. This situation leads to an asynchronous recovery that may smooth global growth while permitting varying leaders and laggards. Critical to the outcome is the fiscal policy response, which America addressed overwhelmingly. The challenge is that the ebullient summer may lead to sluggish growth starting in the fourth quarter.

Exhibit 1. GDP Contribution by Component

Source: Federal Reserve Economic Database, CRM Calculations.

A sword, not a scalpel. The size of America’s policy response to the Pandemic was unseen since the World War II. There is little doubt that the situation called for dramatic policy action. Economic theory leaves little room for debate on whether to support deficient demand. In contrast, there is a material discourse on where and how. The fiscal stimulus evaded the discussion by adding something for everyone (exhibit 2). Indeed, the absence of targeted programs ensures one beneficial outcome: there should be little debate that politicians didn’t try to assuage the concerns of all constituents.

Exhibit 2. American Rescue Plan

Source: Joint Committee on Taxation. Capital Risk calculations for categories.


The programs addressed the major deficiencies of the moment: extended employment benefits, support for State & Local governments, education, and public health concerns. These were all programs that addressed specific needs. The primary concern is the largest disbursement, the direct payments to everyone below a certain income threshold. This stimulus was helpful during the collapse of demand early in the Pandemic. The need for a further stimulus of this type is not evident after the recovery of consumption to near its prior peak. Supporting consumption now reduces future consumption and requires higher future taxes that will also impair future consumption.

The first direct payments did help address a need. Demand plummeted during the shutdown in March and April of 2020. The direct payments of $292 billion helped moderate the deficient demand (exhibit 3). The trouble was the inability to spend the money due to these shutdowns and consumer frugality from the uncertainty of the shutdowns’ length. The unspent money delivered savings that skyrocketed to the highest amount on record. While this outcome was arguably inefficient in timing, it did permit consumers to hoard savings until the Pandemic passed.

Exhibit 3. Direct Stimulus Payments ($, Billions)

Source: Congressional Budget Office estimates.

The subsequent direct payments are the more perplexing decision. In the face of evidence that the first stimulus was largely unspent, the response leading into the election was for another payment to the woebegone consumer of $164 billion. With payrolls still eight million below their peak, this action has some economic justification. A further dose of $411 billion that nearly equaled the prior two programs is the mystery. With savings still abnormally high, this is ineffective means to stimulate employment. The price of the inefficiency will result in a burden for future generations that did not necessarily help the current generation in need.

The second and third direct payments hit the pockets of 11 out of 12 people who were still employed. The benevolence resulted in nearly a two trillion-dollar expansion of household savings in America (exhibit 4). This outcome is beneficial to driving demand for Treasury bonds as people park the money in their bank accounts. The trouble lies in the application where the people in need, the unemployed, do not have a viable path to employment through this action. Yet, their liabilities (e.g., rent) remain the same.

Exhibit 4. US Household Savings

Source: Federal Reserve Economic Database. Four-quarter moving average.

The challenge is the distinction between aggregate demand and marginal demand. For the economy to return to its prior employment peak, the marginal employees (e.g., the unemployed) must return to active engagement in the workforce. The direct payments are an indirect tool of aggregate demand that is susceptible to changes in consumer behavior. The Great Depression caused a generation of consumers to save for a rainy day. The current evidence suggests a parallel dynamic is occurring now. If this situation continues, then the recovery will endure longer than required because of misdirected resources, with future generations bearing the cost via higher taxes.

The secular view is no less disconcerting. First, the wealth inequality in America is exacerbated by this policy choice as the fortunate gain at the expense of the unfortunate. While progressive taxation addresses some of this burden, it still permits the fortunate to leverage their capital and income advantage. They can turn their current income (i.e., direct payments) into capital for the expected future tax increases. In effect, they are borrowing at zero cost with the ability to invest (e.g., equities) at a higher rate of return. This intertemporal arbitrage may further magnify wealth inequality while not enabling current employment growth.

Exhibit 5. Estimated Service Cost and Pay-down Amount of New Federal Debt

Source: Capital Risk calculations based on $4 trillion of new debt at 2% interest rate amortized over 15 years. No Direct Payments excludes the direct stimulus checks from all the fiscal stimulus programs.

The direct payments cost is material with a marginal debt service of $85 billion per year for the next fifteen years. While we can regale in the fourteen million jobs that returned from the abyss of the shutdown, it’s not evident that any of the returning jobs were the result of the direct payments. Thus, these future payments are a burden that will weigh on consumers for a generation. Critically, they will weigh on future policymakers as they determine what fiscal policies to reduce or who pays higher taxes.

The $85 billion marginal debt service from the direct payments will exceed some social programs costs, including Welfare and Development (exhibit 6). Higher than expected interest rates could deliver future costs that approach the annual outlay of the Veterans and Education programs. The marginal cost of these programs will deliver either higher taxes or cuts to future programs. In the latter case, heightened wealth inequality would decrease programs that diminish inter-generational inequality (e.g., Education and Development).

Exhibit 6. US Federal Non-Defense Discretionary Spending

Source: Congressional Budget Office, April 2021. CRM estimate of debt service for direct payments.

The design of fiscal programs during an economic contraction is complex. This challenge is even more so during a once-in-a-century Pandemic. While no program is perfect during these periods, sacrificing the future for the present seems incoherent. This choice is particularly acute because of whom the decision affects. The people most likely impacted by the Pandemic-induced closures (e.g., retail) are the citizens with the lowest wages and who would benefit from the programs that might face future cutbacks. Thus, the choice seems myopic in the long run because it exacerbates growth challenges in the present from investing the payments rather than spending them, and in the future by delivering less productivity growth from a less-educated workforce.

The the direct payments may be gratuitous and unfocused, they are not a strategic threat to the US because most developed countries and regions followed a similar path with their fiscal stimulus. All developed countries will face the same burdens. The question is how future fiscal policy will address the challenges when they arrive. Thus, the suggestion that the fiscal response will lead to higher interest rates, higher taxes, and a lower US Dollar is incoherent with the situation.

Exhibit 7. Forecast for US GDP Growth

Source: CRM estimates. Amounts are annualized rates. Forecast composition altered with consumption front-loaded to the first quarter from the third. The annual growth rate forecast is unchanged. The direct payments will provide a material lift to growth, with most of the benefits arriving in the first and second quarters. The previous forecast had the benefit beginning in the second quarter. For the full year, growth may approach 4.7% and achieve a rate not seen in twenty years (exhibit 7). Exports should climb in the second half as the laggards in vaccine distribution recover. This action should marginally offset the pullback from the domestic consumption boom in the first and second quarters. The future moderation of domestic consumption is the price of current consumption.

The excerpt is the Macro View section of Capital Risk's US Economic Outlook for the first quarter of 2021.

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