The writer is president of Queens’ College, Cambridge university, and adviser to Allianz and Gramercy
When Joe Biden became vice-president 12 years ago, he joined an administration dealing with a major economic heart attack in the form of the financial crisis. Today, the new president leads a country confronting not a single but multiple self-reinforcing crises. Responding well will require supplementing smart economic policy design with agile political manoeuvring at a time when financial markets remain focused on a “pedal-to-the metal” Federal Reserve.
The major challenge in 2009 was to stabilise dysfunctional financial markets threatening to tip the world into a depression. This was achieved through a combination of extraordinary monetary and, to a lesser extent, fiscal responses. Barack Obama’s administration avoided a major economic calamity. But losses in the 2010 midterm elections closed its political window for major legislation, and it was unable to provide a solid runway for high growth that was both inclusive and sustainable.
If anything, today’s financial markets are functioning too well. Conditions are extremely loose: interest rates remain ultra low, asset prices are surging to record highs and financing is abundant for companies that can access capital markets. The financial system challenge for Mr Biden is not a short-term need to address immediate dislocations but the longer-term problem of relinking bubbly markets to economic realities.
Recent data confirm that the US economy is slowing, hit by higher infection rates and deaths from the pandemic. Inequality of income, wealth and opportunity, already high in the US, has worsened. Trust in institutions has been undermined. And, even though we all face the common problem of a virus that is mutating, international efforts to co-ordinate policy have struggled.
These crises are feeding on each other, threatening vicious cycles. No wonder the risk of “scarring” — in which short-term economic problems become stubborn longer-term obstacles to social wellbeing — has become such a concern.
I have argued before for a four-prong approach: provide immediate financial relief to vulnerable segments of the population, improve our fight against Covid-19, counter household financial insecurity, and boost productivity and growth potential, including through a lasting green recovery.
The $1.9tn fiscal package recently announced by Mr Biden seeks to address the first three of these issues. Plans for additional fiscal stimulus, scheduled for February, would take aim at the fourth.
Undoubtedly, some will worry about the efficiency of some of these measures, as well as the longer-term implications for deficits and debt. Yet most pressing questions lie elsewhere. Will the Democrats’ razor-thin congressional majority allow the timely passage of stimulus? Will there be enough “early wins” to facilitate the national unity needed to overcome the health crisis in particular? And how will markets react?
Mr Biden’s two-part plan for fiscal stimulus is an attempt to cut the risk of congressional opposition. But finding ways to build and mobilise national unity is likely to prove hard. Large sections of the US population feel marginalised, undermining collective efforts to deal with common challenges — as we are seeing in attempts to slow Covid-19 infections and increase vaccine adoption.
The markets question is perhaps the most vexing of all. Fed officials have recently felt compelled to adopt an even more accommodating tone despite favourable signs for a large fiscal effort, buoyant capital markets and higher asset prices.
Reacting to a one-week 20 basis points increase in yields on longer-dated government bond debt, Fed chair Jay Powell felt the need to reiterate the central bank’s dovishness. If the yield rise were to continue, it would increase borrowing costs and risk shaking the two major tenets that have bolstered vibrant stock markets: that there is no alternative to buying riskier assets and stocks are cheap based on discounted cash flow models. But the Fed’s constant reassurance only reinforces investor confidence that there are only upsides to investing in markets that have become increasingly disconnected from economic reality.
Early signs suggest that policy design is unlikely to be the main obstacle to the Biden administration’s success. But smart economic policy is a necessary but not sufficient condition for improving both the financial and medical wellbeing of America and the global economy. The new team also needs a high degree of political agility and a much greater sense of national collective responsibility, both political and social.