Stimulus: Sugar Rush Or Complex Carbs?

It’s still not clear whether Congress can walk and chew gum at the same time. Many of us have been riveted by the Senate’s Impeachment drama (I’m sure that many traders switched their TV’s from financial to news stations covering the trial this week), but it is ultimately a distraction from the work that is most meaningful to market participants. That of course is the negotiations over President Biden’s proposed stimulus package.

Equity investors treat stimulus as a definitive positive for investors. Why shouldn’t they? It is clear that prior fiscal measures were crucial to boosting stock prices. Last year’s rapid rises in major equity indices occurred in the wake of unprecedented monetary and fiscal stimuli. There is ample evidence that many stimulus checks were used to fund investment accounts, new and old. One of the surest ways to excite investors is to present them with a situation that had remarkable prior success – especially when that situation involves free money.

Yet if this is such an obvious boon, why are some prominent economists nervous about the way the stimulus package is currently constructed? Are they simply dismal scientists, or is there something to their concerns?

The biggest and most obvious risk from Biden’s proposed stimulus is that it overheats the economy. It is widely expected that the economy will improve organically after a significant percentage of the population is vaccinated. There is pent up demand for a wide range of services such as dining out, spectator sports, travel and leisure, etc., that is likely to be unleashed over the coming months. Considering that fiscal policy works with a lag, it is not unreasonable to fear that the effects of the coming round of stimulus could arrive just as the economy is already returning to normal. 

This is the crux of the argument posed by former Treasury Secretary Lawrence Summers, which he outlined in articles in Bloomberg and the Washington Post. (As a reminder, he served in that role in the Clinton administration and as an economic advisor in the Obama administration.) In the latter publication, he wrote: “There is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation.” Federal Reserve Chairman Powell made it clear the other day that the Fed would be deliberately slow to remove monetary stimulus. It is imaginable, if not probable, that we could overheat the economy if it is naturally improving while still digesting levels of fiscal and monetary stimulus that were appropriate to a weak economy. 

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