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How record fiscal stimulus has boosted the US economy

Preston Caldwell  |  09 Mar 2021Text size  Decrease  Increase  |  
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The US economic recovery paused at the end of 2020, as a third wave of the coronavirus pandemic caused a retreat from the return to normal activity. But we’ve argued that the US economy will be ready for liftoff following the arrival of herd immunity with mass vaccination in mid-2021. A key reason for this is that record US fiscal stimulus has put households and firms in good shape for the recovery.

2020 brought record US fiscal stimulus (and more is coming)

The federal deficit/GDP reached about 16%, the highest level in peacetime US history (and the highest level in any year outside the World War II era).

And 2021 is set to bring a near repeat of this record-shattering level of fiscal stimulus: As shown in the chart below, we project that the federal deficit/GDP will only slip to about 15%. This incorporates our expectation that President Joe Biden’s proposed $1.9 trillion stimulus plan is largely enacted in full.

Exhibit 1

Fiscal stimulus has caused private income to soar

In order to track the financial health of the private sector as a whole, we monitor private domestic income (after taxes). This is the total aftertax income earned by private-sector entities (including both households and firms).

As illustrated below, private domestic income can be broken down into net exports, the government deficit, and private domestic expenditure (consumption plus investment). If households and firms cut their spending, private income will fall as a result, unless it is offset by higher net exports or fiscal stimulus.

When this happened in 2020, fiscal stimulus not only plugged the income gap, it generated 7% private income growth. Other than 2018, this is the fastest growth the country has seen since the mid-1990s. We project that 2021 will also bring about 7.5% private income growth, owing to additional stimulus along with a rebound in private expenditure. We forecast that the cumulative average growth rate of private income from 2019 to 2022 will be 3.9%, actually higher than the 2010-19 average of 3.7%.

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Exhibit 2

Most households' finances will emerge from the pandemic better than ever

With overall private-sector income up in 2020, it's unsurprising that the household sector benefited. While personal income before taxes and transfers was up just 0.3%, disposable personal income jumped 7.2%. The gap was accounted for by net taxes and transfers, which had a large positive effect on disposable income thanks to fiscal stimulus (especially via stimulus checks and unemployment benefits).

This fiscal stimulus boost faded as 2020 went on (especially after the federally funded extra $600 per week in unemployment benefits expired at the end of July). Nevertheless, pretax income had sufficiently recovered in the second half of 2020 such that disposable personal income was still up 4.7% year over year as of December 2020.

Exhibit 3

Households funneled their income windfall into savings, with the personal savings rate jumping in early 2020. As of December 2020, the savings rate was still elevated at 14%, up from 8% in January 2020. This surge in savings has caused household net worth to jump, as shown below.

Exhibit 4

Finances of low- and middle-income households have (in general) improved during pandemic

A key misconception is that this household income boost has benefited only higher-income households and left low- and middle-income households out in the cold. While there isn't good public data that can show precisely how lower-income households' incomes have changed during the pandemic, other data points suggest that their finances are holding up well on average.

It is true that there's been a disparity across income levels in employment outcomes during the pandemic. Job losses have predominantly occurred in a handful of services industries hit hard by social distancing needs (namely restaurants, hospitality, and personal services), and these industries provide lots of lower-wage jobs. According to data gathered by Opportunity Insights, this has resulted in employment falling 21% for workers in the bottom wage quartile through November 2020 versus January 2020 levels, well below the average of about 5%. Meanwhile, employment for workers in the top wage quartile has actually increased 3%.

Exhibit 5

Given lower-income households' outsize job losses, it's clear their pretax income fell behind average income growth in 2020. However, lower-income households also received an outsize benefit from fiscal stimulus in 2020. Recognizing the impact of fiscal stimulus, it's likely that the average low- and middle-income household's disposable personal income increased in 2020.

Below we show our estimates for the 2020 income of a hypothetical US worker who worked the first 13 weeks of 2020 (through late March) but was laid off after that and didn't return to work the rest of the year. We incorporate the impact of the average unemployment benefit received across US states, as well as the impact from the $1,200 stimulus checks sent out starting in March 2020.

This analysis shows that laid-off lower-income workers received extraordinary support during the pandemic, thanks mainly to an increase in unemployment benefits passed with the March 2020 stimulus bill. In particular, the extra $600 per week paid out through July made the benefits extremely progressive, given that it was constant across income levels. In fact, laid-off workers making $30,000 or less experienced way above 100% income replacement—their 2020 incomes were far higher than if they had kept their jobs.

Exhibit 6

Our assessment that financial health for lower-income households didn't deteriorate during the pandemic may seem to fly in the face of anecdotal reports and some other data reporting financial distress among lower-income people.

However, there may be additional reasons for those cases beyond the effects of the pandemic. Namely, households may have already been in poor financial situations before the pandemic. This isn't to downplay the issues faced by lower-income households, but to point out that these issues have been ongoing for many years and aren't going to cause US macroeconomic headwinds in 2021 and upcoming years to any greater extent than they did before the pandemic.

As shown below, the Federal Reserve estimates that net worth was up solidly in the third quarter of 2020 for households across all income levels. Liquid assets (cash and deposits) were up particularly high. Additionally, Federal Reserve data shows that delinquency rates on credit card loans (among commercial bank lenders) fell from 2.7% in the first quarter of 2020 to 2% in the third quarter of 2020. By contrast, credit card delinquency rates surged during the Great Recession by nearly 300 basis points to a peak of 6.8% in the second quarter of 2009.

Lower-income households' spending has performed particularly well during the pandemic. To some extent, this reflects that lower-income households' spending is less discretionary. Still, we would expect more of an impact to these households' spending if their financial situation on average were truly in dire straits. The spike indicated by the preliminary January data, if accurate, very likely reflects the disbursement of stimulus checks from the December 2020 stimulus bill.

Exhibit 7

Exhibit 8

How much can more fiscal stimulus do?

Thanks to mass vaccination plus record levels of fiscal stimulus, there's little doubt now that the US economy not only will recover from the pandemic but that it will test its limits in a way that hasn't been done since before the Great Recession. The key question then turns to where the upper limit is—which we’ll cover in our next report.

is an equity analyst for Morningstar.

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