The Post-Covid Spending Spree’s Stealthy Economic Stimulus

As the Federal Reserve ponders more rate increases to lower inflation, it faces a misunderstood counterbalance: fiscal policy that is stimulating economic growth, employment and wages. This stimulus isn’t captured by mainstream Keynesian measures based on deficits and the ratio of deficits to gross domestic product. Given declines in those gauges following the Covid splurge, Fed Chairman Jerome Powell in public statements has echoed the standard assessment that fiscal policy had become restrictive to growth.

Yet this assessment based on deficit measures is misleading and ignores the measurably stimulative effects of the Biden administration’s post-Covid legislation. The Infrastructure Investment and Jobs Act of 2021 authorized $1 trillion of government investment over 10 years. The Chips and Science Act of 2022 authorized $278 billion on energy projects, including highly stimulative tax credits. The misnamed Inflation Reduction Act is providing $499 billion in tax credits and other subsidies. The Energy Department’s heavily subsidized loan guarantees are spurring big increases in private business investment.

Together, these initiatives represent one of the largest government spending programs directed at the nation’s infrastructure and industry since the 1930s. The goals include bolstering manufacturing, shifting production and consumption toward renewable energy, creating jobs that pay well, and expanding government’s role in the economy.

History shows that the government has a relatively poor track record of picking productivity-enhancing projects compared with market-determined private-sector investments. It’s too early to assess whether President Biden’s industrial policies will lift productivity or improve standards of living relative to their costs. What is clear is that they are currently stimulating economic growth.

Standard deficit-based measures of fiscal policy capture the flows of government spending and tax receipts, but don’t reflect the allocative and economic effects of these programs. Yet that’s what fiscal policies do. They allocate and redistribute national resources, influencing economic behavior and outcomes.

Mr. Biden’s legislation authorizes spending for as long as 10 years, and the spending and stimulus are ramping up. Accordingly, their economic effects shouldn’t be considered transitory. Unlike the government’s Covid income-support checks and other transfer payments that are counted in GDP only when they are spent, the U.S. Bureau of Economic Analysis considers almost all spending for the Infrastructure Investment and Jobs Act and Chips Act as government purchases that “absorb” national resources and thus counts them directly in GDP. Since mid-2022, increases in government purchases have constituted roughly 20% of the rise in GDP. Government investment generates fiscal multipliers significantly higher than multipliers on transfer payments, underlining the current stimulus.

With the 2024 presidential election looming, the Biden administration has a political incentive to step up spending under the Infrastructure Investment and Jobs Act on projects like improving roads and building bridges that also create high-paying union jobs.

The Chips and Science Act focuses on scientific research and development of technologies the administration deems critical to the U.S. It allocates $52.7 billion in spending and tax credits to chip manufacturing. Its 25% tax credits have sparked a building boom in chip-making facilities and electrical power and energy projects. This has contributed to a 2.9% increase in business fixed investment over the past four quarters even as the Fed raised rates by 5 percentage points. Continuing increases in government and private investment for the infrastructure law, Chips and Inflation Reduction Act subsidies and government loans may continue to provide a powerful buffer against tighter monetary policy.

Meanwhile, a portion of the federal government’s $5 trillion in Covid spending continues to flow into the economy. While households have spent most of their savings cushions, state and local governments saved almost all the $500 billion they received in federal grants. Their holdings of U.S. Treasury securities have surged to $1.55 trillion from their pre-pandemic average of $775 billion. As state and local governments spend their excess savings, economic activity will be stimulated long after federal deficits are recorded.

Ending the moratorium on federal student loans means roughly 20 million borrowers will have to resume servicing their loans. The moratorium has been costing the federal government about $5 billion a month. But the hit to borrowers’ spending will be more than offset by cost-of-living adjustments to entitlement programs. The 8.7% cost-of-living adjustment for Social Security is adding more than $100 billion to nominal disposable income in 2023. Cost-of-living adjustments for all entitlement spending programs are adding about $250 billion. This contributes to the 4% increase in real disposable income in the past year that is supporting consumer spending.

After failing to predict the economic and inflationary effects of the unprecedented $5 trillion in Covid spending, the Fed must properly assess current fiscal policies. Continuing fiscal stimulus requires the Fed to raise rates further to achieve its 2% inflation target.

Mr. Levy is senior economist at Berenberg Capital Markets and a visiting scholar at the Hoover Institution.