The CARES Act
Trump lost the US Presidential election primarily because of his irresponsible response to Covid-19. Despite the mounting death toll from the spread of the virus, Trump aggressively promoted defiance of masking and social distancing – a policy endorsed by his own administration! The in-person rallies he held across the US, with the supporters without masks congregating defiantly became super spreader events. After being told that the lawmakers would proceed without his consent, Trump reluctantly signed the Coronavirus Aid, Relief and Economic Security Act, also known as the CARES Act, a $2.2 trillion economic stimuli bill into law on March 27, 2020. The largest relief package in US history had been passed unanimously on March 25 by voice vote in the Senate and on March 26 in Congress. Regarded as Phase 3 of response from the lawmakers, it followed Phase 1 response worth $8.3 billion for spurring coronavirus vaccine research and development and Phase 2 response worth $104 billion to support sick leave and unemployment benefits for workers. In addition to one-time cash payments to individuals and families, the CARES Act provided funds for increased unemployment benefits, funds to small businesses, and funds to state and local governments. As the virus kept wreaking havoc in the US, the next round of government assistance worth $920 billion was signed into law on December 28, 2020.
Biden’s American Rescue Plan
Biden fought the Presidential election with the promise to use science to deal with the virus and to assist tens of millions of citizens who were hurting due to the virus. Biden’s Covid-19 stimulus bill worth $1.9 trillion, known as the American Rescue Plan, 2021 was signed into law just before the federal unemployment benefits were to expire on March 14, 2021. The Plan extended the unemployment benefits through September 6, 2021, with weekly federal benefits retained at $300 per person. The Plan includes allocation of funds to reopen schools; provides unemployment insurance; aids small businesses, landlords, and renters; expands the Affordable Care Act (health insurance); provides child tax credit, and supports vaccine distribution. The Plan was heavily criticized by the Republicans as they argued that the continued strong recovery of the US economy indicated that there was no need to continue government support at the scale proposed by Biden. The Plan however had robust popular support with about two-thirds of Americans in favor of the Plan. Altogether, the US government would spend over $5 trillion (over 25% of US GDP) to directly help US citizens deal with the impact of Covid-19. Even as the percentage of GDP, this is one of the largest direct assistance provided by the government of any country to its citizens.
The Macro Impact
Two of the most-watched macro statistics to assess the state of the US economy are the unemployment rate and the inflation rate. After hitting a peak of 14.8% in April 2020, the worst since the great depression, the unemployment rate had shown a secular decline to 6% by March 2021. With a strong pick up in the economy, following the immense success of Biden’s vaccination program, it was widely expected that the economy would add 1 million jobs in April 2021, with some even predicting twice that number. Therefore, at 266,000, the number of jobs the US economy added in April 2021 came as a big (negative) surprise. Simultaneously, the CPI (Consumer Price Index) rose to 0.8% for April (on a seasonally adjusted basis), and 4.2% over the last 12 months (not seasonally adjusted). The two statistics have thrown a spanner in the framework laid out by the US Fed on interest rates. To be able to keep the interest rates low till the economy healed, the Fed had changed its policy of inflation targeting by switching over to targeting a 2% average inflation rate, instead of being guided by the spot (latest) inflation rate. In addition, the Fed Chair repeatedly emphasized that the policy would also be guided by the unemployment rate in the economy, as growth without a reduction in the unemployment rate was not acceptable. The Fed estimated that the economy will return to a healthier 4.5% unemployment rate in 2021, 3.9% in 2022, and 3.5% in 2023.
The Stoic Fed Chair
Jerome Powell (the Fed Chair) has repeatedly vowed that the Fed rates will be kept low till the economy reaches an acceptable level of employment. Responding to the spike in the CPI in April 2021, he opined that the increase was transitory and that the rate of inflation would settle down to the Fed’s target of 2% average inflation rate. He, however, offered no explanation or justification for his belief. Surprisingly, the bond market behaved with the conviction that the Fed’s easy money stance would indeed continue despite the significant rise in the inflation rate. After a brief surge in the bond yields, the US treasury rates declined.
In the meantime, Biden has proposed a revised infrastructure spending plan of $1.7 trillion and a budget for 2022 of $6 trillion, signaling thereby continuance of a much greater role of the federal government in the US economy and lives of Americans. The US fiscal and monetary policies are thus fully aligned to maintain significantly excessive liquidity in the US and global markets. How long would Fed be able to convince the bond market that inflation rates would remain benign?
The Gap Between Unemployment and Minimum Wage Rates
Including the unemployment benefits being paid by the states, the continuance of the federal unemployment benefit of $300 has raised the total unemployment benefit to $618 per week. This is more than the $15 per hour of wage rate for the standard 40-hour workweek. The current federal minimum wage rate in the US is $10.95 per hour. The prevailing minimum wage rates across states vary widely, with the lowest being $5.25 (Georgia and Wyoming), the highest being $15 (District of Columbia), and the median being $10.1 per hour.
The Impact on Businesses and Economy
In addition to earning $15 an hour, staying at home also eliminates the costs of travel to work and childcare. It is therefore hardly surprising that the number of jobs added in April 2021 at 266,000 was significantly lower than the addition of 1-2 million expected for the month. Why would anyone actively seek employment? Is it not rational to stay at home? As a result of the huge gap between unemployment and the minimum wage rates, businesses have had to offer much higher compensations to get people to work for them. The resulting higher cost of doing business and the supply side constraints due to people’s unwillingness to work have coincided with a rise in the aggregate consumption demand in the economy. It is therefore hardly surprising that the outcome has been a significant rise in the inflation rate – an unintended consequence of the laudable policy choice of the US government to help citizens in distress.
How May It Play Out?
The excessive dollar liquidity from loose fiscal and monetary policies also implies a weaker dollar, which in turn implies a higher cost of imported items and a higher US inflation rate, which in turn would hurt the people in the low-income segment – precisely the people whom Biden desires to help. If the April employment and inflation figures are a pre-cursor to a trend that would sustain till the federal unemployment benefits end by the first week of September, the nascent revival of the US economy would be jeopardized. The US Fed may have to rethink its stated commitment to keep Fed rates near zero through 2022.
The unemployment and the inflation rates for the month of May would be out in the first week of June. They would test the Fed’s resolve on easy monetary policy. Any sign of weakening resolve could send the bond rates higher and the stock prices lower.