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New fiscal stimulus likely to be underwhelming

By: Paul Ashworth, Chief US Economist,

• The bipartisan infrastructure deal, which could be passed by end-September, would provide no meaningful boost to the economy over the next couple of years. The $3.5trn spending package that Democrats aim to pass via reconciliation later this year could provide more stimulus, but we suspect that spending would be largely offset by tax increases and there is a strong possibility that centrists, in not just the Senate but the House too, will refuse to support it.

•Divisions in the Democratic party mean that they have opted for a twin-track approach to pass Biden’s original spending proposals. A modest $550bn infrastructure bill, which has been crafted to attract bipartisan support, has been approved by the Senate but the House won’t vote on it until late September. Before supporting it, the Democratic progressives in the House want to ensure more progress is made on the $3.5trn spending plan they hope to pass via reconciliation later this year. That reconciliation will include the remaining $1.5trn from Biden’s American Jobs Plan, which focused on infrastructure, and around $2.0trn from the American Families Plan, which focused on social welfare spending. The reconciliation would only require a simple majority in the Senate, but even that may be impossible to achieve, as some centrist Democratic Senators have already voiced strong opposition and even centrists in the House have realised that the Democrats’ modest majority gives them leverage.

•The infrastructure bill has been repeatedly described as “historic”, but it is a complete non-event for the economy. It includes only $550bn in new funding, which would be spread over a full decade. According to the CBO, once the various revenue-raising offsets are accounted for, the bill amounts to only $250bn in net stimulus. Furthermore, since infrastructure spending takes considerable time to get underway, what little boost to the economy it would provide won’t occur until the middle of this decade. The CBO estimates that the bill would translate into a minor fiscal tightening in fiscal year 2022 and only a trivial loosening in 2023. Even at its peak in 2026, the bill would add only $60bn to the deficit, which is equivalent to 0.3% of today’s GDP. The final nail in the coffin is that, according to the CBO, the additional infrastructure spending will add only 0.1% to the level of GDP in 2035. We agree that the additional spending is simply too small to boost productivity and the economy’s supply-side potential.

•The $3.5trn in additional spending that the Democrats are attempting to pass via a new budget reconciliation could, in theory, provide more of a near-term boost to the economy. But we suspect that additional spending would be largely offset by increases in taxes on corporates and high-income earners, meaning that the net impact on the deficit and the economy would be much smaller. Moreover, with a handful of centrist Democrats in the Senate already expressing their opposition to such a substantial increase in spending, the reconciliation may not pass at all, or pass only after it is reduced in size.

•Complicating the near-term fiscal outlook, Congress also needs to pass either a budget or a continuing spending resolution to prevent a partial Federal government shutdown from October 1st and, separately or at the same time, it also needs to agree on an increase, or a new temporary suspension, of the debt ceiling. Without the latter, the Treasury could end up defaulting on its debts in either October or November.

•We don’t expect the Delta variant-related surge in coronavirus cases to weigh heavily on the economy, but if we’re wrong, that could prompt a push for more short-term stimulus, presumably focused again on one-off stimulus cheques and a temporary boost to unemployment benefits. To some extent, the recent surge in inflation makes it less likely that there would be any additional short-term stimulus, but the government’s borrowing costs have fallen, with the 10-year Treasury yield dropping back to only 1.3%. Moreover, if the Delta variant really was weighing on the economy, that would presumably trigger a renewed wave of price declines too, as demand dropped well below the economy’s supply potential again. If the Republicans refused to sign on, however, the Democrats would have to roll that stimulus into their one reconciliation for this coming fiscal year, further complicating the already difficult negotiations.

•Beyond this year, Biden’s plummeting approval rating (it has dropped below 50%) makes it more likely that the Republicans will regain control of the Senate and/or the House in the November 2022 mid-term elections. Under those circumstances, we would expect two years of gridlock.

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