The Future of Fiscal Policy

Federal deficits and debt relative to GDP now at World War II levels

On Sept. 21, 2021, Investopedia, in partnership with another member of the Dotdash Meredith online publishing family, Verywell, hosted a unique virtual conference: “Your Money, Your Health.” This conference was designed to 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 that you need to reemerge mentally and physically sound and financially prepared in 2022.

Two of the panel discussions during that conference were “Investing Through the Pandemic: How the Pandemic Has Changed Investor Behavior and Impacted Global Markets” and “Healing the Economic Scars of the Pandemic.” An important topic during these sessions was the future of fiscal policy and its impact on our readers. Among the financial experts scheduled to participate were 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 policy makers 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

Per the "Your Money Your Health" conference: "It's not really a good idea to have interest rates this low and have this much fiscal stimulus when you have a healthy economy. You're going to overheat things. And so I do think that this lower inflation, low interest rate environment is likely to stick for a while, but we will see a little bit of edging out of this unusually weak interest rate and inflation environment."

"The Fed will succeed in what they've said they want to do. They want to not create runaway inflation but create a little bit of "lubricants" into the economy with a bit of inflation. And that allows them then to start raising interest rates. And the reason that's important is we know at some point there's going to be another crisis and in a sense, they need to rearm themselves to reload the policy gun. And so I view it as a good sign when the Fed is able to, due to the recovery in the economy, stop their bond purchases, start raising interest rates, and set themselves up for the next crisis."

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 policy makers 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. 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 the second quarter (Q2) of 2021.

COVID-19 Stimulus and Relief Packages

Congress passed three full packages and one supplement in March and April of 2020, most notably the Coronavirus Aid, Relief, and Economic Security (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, healthcare 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.

Article Sources
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  1. Charles Schwab & Co. “You Take My Breadth Away: Market’s Underlying Deterioration.”

  2. Congressional Budget Office. “Additional Information About the Updated Budget and Economic Outlook: 2021 to 2031.”

  3. “The Federal Fiscal Year.”

  4. Congressional Budget Office. “Additional Information About the Updated Budget and Economic Outlook: 2021 to 2031,” Page 6 (Page 10 of PDF).

  5. Investopedia. “U.S. COVID-19 Stimulus and Relief.”

  6. Federal Reserve Bank of St. Louis. “Gross Domestic Product (GDP).”

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