Investing News

The Future of Fiscal Policy

On Sept. 21, 2021, Investopedia, in partnership with another member of the Dotdash online publishing family, Verywell, is set to host a unique virtual conference: “Your Money, Your Health.” This conference will help financial advisors coach clients on the great financial reset, equip investors with smart insights now, and provide you with the most reliable and understandable health and wealth information you need to re-emerge mentally and physically sound and financially prepared in 2022.

Two of the panel discussions during that conference will be “Investing Through the Pandemic: How the Pandemic has Changed Investor Behavior and Impacted Global Markets” and “Healing the Economic Scars of the Pandemic.” A likely topic during one or both of those sessions will be the future of fiscal policy and its impact on our readers. Among the financial experts scheduled to participate will be Liz Ann Sonders, chief investment strategist at Charles Schwab & Co., Inc., and Ethan Harris, head of global economics research at Bank of America Merrill Lynch Global Research. Below we offer excepts from their most recent research notes.

Key Takeaways

  • Relative to gross domestic product (GDP), U.S. federal deficits and debt are at World War II levels.
  • Federal debt is now above 100% of GDP and will continue to grow.
  • While pandemic-related spending should fall sharply after 2021, the annual budget deficit will continue to be large, adding to debt.
  • A key issue for policymakers is whether servicing this level of debt is sustainable in the long run, especially if interest rates rise.

From Liz Ann Sonders

“As summer winds down, we soon head into September—historically the worst month for stocks in terms of average performance. Aside from seasonality, there are several risks with which the market is confronting … including deteriorating breadth, fading monetary and fiscal stimulus, peak earnings/economic growth rates, and of course the delta variant. Individually or collectively, though, they should not be taken as a ‘get out’ message.”

From Ethan Harris

“We have remained on the optimistic end of the global growth consensus since late last year, but we are now downshifting our view. Most importantly, the twin engines of global growth—the U.S. and China—are sputtering. While the U.S. slowdown is due to both the surge in COVID cases and severe supply-side constraints, China’s slowdown is mainly due to policy tightening, combined with a slow response to the weaker data. However, in both instances, we expect a return to solid growth starting in 4Q.”

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The Challenge Ahead for Fiscal Policy

The Congressional Budget Office (CBO) projects that the federal budget deficit will be $3.0 trillion in 2021. At 13.4% of gross domestic product (GDP), this would be the second-largest shortfall since 1945, exceeded only by the 14.9% figure recorded in 2020, when the deficit was $3.1 trillion.

Note that, since 1977, the fiscal year for the federal government has ended on Sept. 30. From 1842 to 1976, it ended on June 30, after coinciding with the calendar year prior to 1842.

The CBO forecasts that deficits will fall over the next few years as pandemic-related spending decreases. However, the deficit will rise in most years thereafter, driven by rising interest costs and increased spending on entitlement programs, reaching 5.5% of GDP in 2031. Total federal outlays were $6.6 trillion in 2020 and are currently projected to be $6.8 trillion in 2021 and $5.5 trillion in 2022.

Federal debt held by the public currently is at 102.7% of GDP, and the CBO projects it to reach 106.4% by 2031. The previous high was 106.1% in 1946, in the immediate aftermath of World War II, which was a period of massive military spending. Since reaching a recent low of 31.5% in 2001, this ratio has been on a sharp uptrend.

Whether these levels of federal spending and indebtedness are sustainable in the long run is a key concern for policymakers going forward.

Federal Spending Surges in 2020 and 2021

The unfolding COVID-19 crisis sent the U.S. economy into a sharp recession starting in February 2020, with the unemployment rate reaching 14.7% by April 2020, and real (inflation-adjusted) gross domestic product (GDP), falling by 3.5% year over year (YOY) in 2020. Meanwhile, the U.S. stock market entered a bear market in March 2020, and the S&P 500 Index did not rebound to its pre-pandemic highs until June 2020.

In 2020 and 2021, the U.S. federal government passed five main stimulus and relief packages, plus one supplemental package, related to COVID-19. In aggregate, the government appropriated more than $5.6 trillion, as detailed below. This is more than 25% of annual U.S. GDP, based on the annualized rate of $22.7 trillion recorded in Q2 2021.

COVID-19 Stimulus and Relief Packages

Congress passed three full packages and one supplement in March and April 2020, most notably the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which appropriated $2.3 trillion for a variety of efforts. It is the largest single relief package in U.S. history in terms of the nominal dollar (not adjusted for inflation) amount. A supplementary package appropriated an additional $484 billion.

The fourth package was the $900 billion stimulus and relief bill attached to the main omnibus budget bill passed on Dec. 21, 2020. The fifth was the $1.9 trillion American Rescue Plan Act, signed into law on March 11, 2021. Taken as a whole, the five packages had these key provisions:

  • Direct cash payments to individuals
  • Unemployment benefits extended to freelancers and gig workers
  • Increases in the amount and duration of unemployment benefits
  • Waiving early withdrawal penalties on 401(k) accounts, subject to limitations
  • Mortgage forbearance and a moratorium on foreclosures on federally-backed mortgages
  • Loans and grants to keep companies afloat and people employed, partly through the Paycheck Protection Program (PPP) and the Economic Injury Disaster Loan (EIDL) program
  • Grants to hospitals, health care providers, schools, universities, live performance venues, and state and local governments
  • Creating the Pandemic Unemployment Assistance (PUA) program for self-employed and contract workers and the Pandemic Emergency Unemployment Compensation (PEUC) program for people who had exhausted their unemployment assistance
  • Increasing through 2022 the maximum annual Child Tax Credit, subject to income limitations
  • Exempting some unemployment benefits from federal taxes, subject to income limitations

Additionally, both the Trump and Biden administrations have issued a variety of executive orders designed to offer relief amid the COVID-19 crisis. Among these have been: extending deadlines for paying federal taxes; student loan forbearance and forgiveness; the Lost Wages Assistance (LWA) program; temporary assistance to homeowners and renters; deferral of payroll taxes for individuals, subject to income limitations; and temporary halts on housing evictions.