Updated: Dec 30, 2022
As advanced economies such as the UK & US resorted to large fiscal stimuli, the COVID-19 pandemic had brought with it some of the largest government intervention schemes seen in modern history. With this, the governments of advanced economies attempted to rectify their mistakes from the financial crisis. Yet, the nature of the pandemic meant that many previous trends were distorted, and, as such, Economists debated the successes and effects of such fiscal measures. As such, the following column will assess the impacts of fiscal policy activism and how this initial support amid the worst of the pandemic supported the Industrial Circulation, the ‘real economy.’ Once these impacts are considered, the column will present the argument that this initial injection did not yield a recovery, or, inflation. Rather, fiscal policy activism created the climate for loose Monetary Policy to continue the recovery to showcase the importance of both interventions.
The objective of this fiscal policy activism was to prevent the large rise in unemployment that could potentially occur due to COVID as policymakers looked back to the Financial Crisis where unemployment rates rose drastically. (Figure 1) When looking at the US, it could be argued that policymakers successfully learnt from their past mistakes as although US unemployment did peak at its highest levels, strong fiscal support from the Federal government yielded a much faster recovery in the US labour market. (Figure 1) Moreover, in the UK, the implementation of the Furlough Scheme was successful in ensuring that unemployment rates would stabilise and as such the UK labour market was protected. (Figure 1) As such, countercyclical fiscal support can stimulate the industrial circulation of economies in the short term, which, can effectively support labour markets, a key element in maintaining the income component of the Keynesian circular flow.
However, it should be noted that not all Fiscal stimulus packages introduced during the pandemic were directly inflationary. For the UK, Furlough only covered a maximum of 80% of one's wage, (GOV.UK, 2020) meaning it is difficult to argue that Furlough on its own would have allowed spending to fully recover to pre-pandemic levels. Furlough was not additional income, it was a substitute for lost income. However, when looking at the US, where stimulus packages were given to all households despite employment status the fiscal response being valued at 27% of GDP, (Taylor, 2021) did contribute to higher spending in the short term. This is opposed to Monetary Policy, which, is dependent on the time lag associated with the transmission mechanism and the real balance effect. As such, Monetary Policy, as a general tool for boosting spending, at least in the short-run, is ineffective. Yet, in the medium to long term, a strong Monetary backdrop for an economy is of significant importance in maintaining recoveries in expenditure. Both the UK & US saw a wave of consumption due to the Fiscal stimulus, evidenced by the high initial change in the rate of inflation in March 2021 (Figure 2) as a temporary spending boom occurred with vaccine rates rising. (Figure 3) With Fiscal policy spearheading an initial recovery, Monetary Policy was responsible for continuing the movement. Strong fiscal support bought time for the real balance effect to settle and for transmission mechanisms to leak money from the financial circulation into the industrial one. With this, the financial sector was ready to create credit for lenders, who were willing to demand debt with their employment safeguarded by derived demand that was a product of fiscal stimulus. Hence, fiscal activism was responsible for a short-term recovery in spending, which, was an essential building block in creating an environment where Monetary Policy measures could continue spending, illustrating the importance of both types of policies.
GOV.UK (2020). Calculate How Much You Can Claim Using the Coronavirus Job Retention Scheme. [online] GOV.UK. Available at: https://www.gov.uk/guidance/calculate-how-much-you-can-claim-using-the-coronavirus-job-retention-scheme.
Taylor, A. (2021). How the $1.9 trillion U.S. stimulus package compares with other countries’ coronavirus spending. Washington Post. [online] 5 Apr. Available at: https://www.washingtonpost.com/world/2021/03/10/coronavirus-stimulus-international-comparison/.