To mitigate COVID in the winter months, there will likely be calls for another economic shutdown. However, a second shutdown could be catastrophic for our economy and thus, should be avoided at almost all cost.
Gross Domestic Product (GDP) is the total value of all final goods and services produced in the economy, measured over a year or a quarter of a year. GDP also equals the total income generated in the economy during that same time period, as income is generated by producing goods and services. If a business produces no output, it earns no income, hence the link between the two. Consequently, if GDP decreases, both output and income fall. The contraction in output has received widespread coverage, but the link between that and income has not received enough attention.
The reason is that aggressive fiscal policy by the President and Congress in March through the CARES (Coronavirus Aid, Relief, and Economic Security) Act, coupled with aggressive monetary policy by the Federal Reserve, replaced this lost income. The CARES Act provided aid such as the extra $600 per week in unemployment benefits, a $1,200 check to Americans falling below a certain income threshold, loans and grants to small businesses from the Paycheck Protection Program, and aid to state and local governments.
These actions give the illusion that output can fall without income also falling. The cost of the CARES Act is estimated to be approximately $2 trillion. The Federal Reserve financed a large portion of this by, essentially, printing money. The M1 money supply, which includes bank deposits and currency in circulation, increased by 40% in 2020, increasing from $4 trillion to $5.6 trillion. We are fortunate that this did not lead to 40% inflation. We are unlikely to be so fortunate should further money creation occur to fund additional stimulus spending during a new shutdown.
This spending, coupled with falling tax revenue, also pushed the budget deficit to over $3 trillion in 2020. Total federal debt is now 105% of GDP, a level not seen since World War II. The federal government can currently borrow at low interest rates. However, at some point, the bond market will likely begin to question the government’s ability to repay what it has borrowed. The bond market may begin demanding higher interest rates in order to continue lending to the federal government or just stop lending altogether. If this occurs, the federal government would likely resort to simply printing money to finance its spending, resulting in inflation.
If there was a shutdown but no second stimulus package, then income would fall to match the lower level of output. GDP contracted by 33% in the second quarter of 2020, meaning if shutdown lasted all year, output and thus income would be 33% lower than the start of the year. This would wipe-out over 20 years of economic growth, and the average American would see his/her standard of living fall by a third. Thus, absent a second coming of the bubonic plague, a second shutdown should be avoided.
