Keating: Penny-Pinching in a Crisis

May 27, 2020

by Maryann O. Keating, Ph.D.

The affluent generally have no need to second-guess themselves on spending. The rest of us do well to question practically every single expenditures in terms of our pocketbooks. 

Is it appropriate to evaluate a national response to COVID-19 in terms of the dollar cost for testing of all Americans for COVID-19 paid either by individuals, corporations, Medicaid or Medicare? Facing such a serious crisis, is it unseemly to discuss cost versus benefits? Do government deficits and the national debt matter in these times?  

The Federal Reserve (FED), acting as fiscal agent for the U.S. Federal Government, is required to either purchase or sell all new debt securities issued by the Treasury. This alone amounted to $1.5 trillion in new debt securities issued during March and April of this year. U.S. government debt outstanding is estimated to reach 101 percent of GDP by the end of the fiscal year — up from 79 percent at the start of fiscal 2020. 

Alan Blinder, former vice chairman of the Federal Reserve, writes that any concern about expansionary fiscal and monetary policy to deal with the economic fallout from COVID-19 crisis can be postponed until “tomorrow” (“On Coronavirus Debt, Heed the Wisdom of Scarlett O’Hara,” The Wall Street Journal, May 14, 2020).  

Because the FED is able to sell government securities today at super-low interest rates, both to the U.S. public and on world markets, Blinder anticipates no adverse consequences. This assumes, of course, that future annual percentage increases in GDP exceed both the rate of at which the national debt is increasing and the interest rate paid by taxpayers to service outstanding debt.

What if, rather than selling securities to the general public, the FED holds these securities and thereby increases bank reserves that in turn result in monetizing a significant portion of this debt? Will this huge increase in the money supply cause inflation? Blinder thinks not and refers to our experience following the Great Recession of 2008 in which inflation was felt to be too low rather than too high.  

Blinder, therefore, concludes that present government deficits and increasing national debt are neither worrisome nor unsustainable. However, Stephen Harper, a former Conservative Canadian prime minister, offers a different opinion. Writing on the fiscal response to COVID-19 of nations around the world, he suggests that massive doses of deficit government spending are neither required to get out of this crisis, nor needed in its aftermath (“After Covid, Government Will Have to Shrink,” The Wall Street Journal, May 13, 2020).  

Harper argues that, although people turn to government in crises, no amount of government spending can compensate for the tens of millions that have lost jobs and the thousands of businesses that have closed. He believes that following the pandemic the need will, and must, shift to jobs, growth and wealth-creation requiring more market activity and less government intervention.  

Harper, citing the multiple sovereign debt crises of Mexico, Canada and Greece a decade ago, believes that the suggestion that governments can never run out of revenue is nonsensical. (COVID-19 spending, grants, loans, and contingent liabilities contribute to deficits on government financial statements requiring an immediate need for collecting more taxes or increases in the stock of our outstanding national debt.)

Unfortunately, the inevitable spending cuts and tax hikes needed to restore public sector viability will encounter serious resistance. Harper suggests that calls for increasing the limited stipends to low income families and businesses are a factor, but the greater threat to sustainable government spending is the delusion of guaranteed maximum income for those laid off from public institutions and accustomed to higher salaries and benefits.  

Harper concludes that in the absence of astronomical global growth, governments that fail to practice mild austerity will experience the brutal consequences of recession and stagnation.  

Consider the difficulty of practicing austerity merely with respect to the testing of Americans for COVID-19, assuming reasonably that the full cost per test is about $100 per person. Given a U.S. mid-2020 population of 331,002,651, four annual tests per person would exceed $132 billion. Interest on the U.S. debt is estimated to be $378 billion in fiscal year 2021. These two expenditures alone would account for over 13 percent of the $3.863 trillion in expected federal government tax revenue in 2021. 

Because the U.S., given the role of the dollar in world markets, can presently issue debt at relatively low rates, it is tempting to ignore the warnings of the former Canadian prime minister. The reality, however, is that for any country scarcity requires tough choices and a consensus on what is really important.  

Maryann O. Keating, Ph.D., a resident of South Bend and an adjunct scholar of the Indiana Policy Review Foundation, is co-author of “Microeconomics for Public Managers,” Wiley/Blackwell.


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