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Economic Research: Within Reach: How Stimulus Proposals Lift U.S. GDP To Pre-Pandemic Levels


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Economic Research: Within Reach: How Stimulus Proposals Lift U.S. GDP To Pre-Pandemic Levels

(Editor's Note: This analysis was conducted before the Bureau of Economic Analysis' fourth-quarter 2020 GDP report was released.)

President Joe Biden hit the ground running with an aggressive agenda to steady the health of the American population and strengthen the U.S. economy, as we have expected since November (see "Economic Research: Next Steps For President-Elect Biden: Containing Coronavirus And Stabilizing The U.S. Economy," Nov. 19, 2020).

Even before Biden took office, he announced a $1.9 trillion stimulus package, the American Rescue Plan (ARP), which is at the top of his first 100-day agenda(1). His team has also hinted that a second package of longer-term policy solutions--such as infrastructure and climate--is in the works (expected to be announced later in February).

On Dec. 21, we saw $900 billion deficit spending signed into law, which extended lifelines to the unemployed through March and additional support to businesses. Before December, total fiscal stimulus amounted to around $3 trillion in 2020 (about 14% of 2019 GDP), and assuming ARP is approved, the economy is now looking at a potential $2.8 trillion (about 13% of 2019 GDP) of additional government support for various groups hit hard by the pandemic.

With a Democratic majority in both houses (albeit a slim one), Biden has some leverage in pushing through his policy objectives, including more stimulus. Still, promises are not policies, and some negotiation will be required to pass his plan. Indeed, on Jan. 31, Republican senators offered a counterproposal of $600 billion in additional stimulus. With the December agreement of $900 billion, their proposal would bring total additional stimulus to $1.5 billion, mirroring our December upside forecast.


Using Congressional Budget Office (CBO) short-term multipliers, we find that if the $1.9 trillion package were put into law, the U.S. economy would reach precrisis levels in the second quarter of 2021, with a stronger demand-driven path of growth through 2023. In our $1 trillion baseline estimated on Dec. 15, GDP returns to precrisis levels by the third quarter 2021 (see chart 1 and "Our Approach"). (For more on our analysis, please see "Economic Research: Bang For The Buck: How U.S. Fiscal Stimulus Could Benefit The Recovery," Dec. 15, 2020.)

Both stimulus scenarios boosted economic activity above the "no stimulus" scenario. The $1 trillion base case meant 2021 GDP would be $311 billion larger than without stimulus. We found that ARP, as it is proposed by President Biden, would provide an extra 3.5% lift, or an additional $677 billion, to GDP in 2021 relative to our $1 trillion base case. While the policies accelerate "filling in the demand hole" this year, they are temporary, and GDP will drift back to a lower pace of growth.

However, this multiplier approach doesn't consider the effects the package will have on the unemployment rate, inflation, and Federal Reserve action. Borrowing from Okun's law, which is an empirical relationship between changes in the unemployment rate and GDP, we approximate that the unemployment rate in the Biden (ARP) scenario would be 5% by year-end 2021, versus 6% in our $1 trillion December base case(2).

Biden Plan And Recession Risk

Although it is still unclear how large of a stimulus package will reach law, the Democrat-led majority in Congress has significantly increased chances that some additional stimulus will be agreed on soon. We believe that additional stimulus will help lower recession risk. We now see the risk of recession over the next 12 months at 20%- 25%, closer to the lower end of the range (and down from 25%- 30% in December).

Indeed, we believe that even $600 billion on top of the December $900 billion agreement (mirroring our December upside scenario of $1.5 trillion) would give the U.S. recovery an extra lift as it navigates out from the COVID-19 hole (see "Economic Research: Staying Home For The Holidays," Dec. 2, 2020). In such a scenario, the U.S. economy would still reach precrisis levels by second-quarter 2021, with the economy $490 billion larger than with no stimulus. The unemployment rate would reach its precrisis rate, under 4%, by mid-2023, one year earlier than in our base case with a $1 trillion stimulus.

Biden Plan And The Fed

The Biden plan's boost to economic activity will also likely lead to higher prices and tighter Fed policy than is assumed in our baseline. In our December upside scenario, the economic boost from an additional $500 billion in stimulus would already give the Fed reason to raise rates in mid-2023--also one year earlier than in our base case with a $1 trillion stimulus.

For now, social distancing will keep a lid on the economic activity and inflation that such a large package would normally generate. Price pressures will likely pick up once social distancing ebbs, however. A stronger economy will allow the Fed to take away monetary support sooner than in our baseline forecast, confident that the economy will now be able to stand on its own two feet.

That said, the Fed will be cautious in tightening the reins. Even if a large package were approved this year, we don't expect the Fed to raise rates quickly as it keeps a watchful eye on the (hopefully) strengthening economy. It will watch the slack in the overall economy (output gap) as well as the labor market (unemployment rates) for any signs of demand-driven price pressures. Moreover, the Fed's new monetary approach--which adopts an "average inflation targeting" framework and allows for "modest" overshoot of the target--will give it more room to stay on the sidelines. We don't expect a bigger stimulus package would bring the Fed to raise rates this year. While chances of a rate hike increase with additional stimulus, whether it raises rates the following year, will, as the Fed saying goes, depend on the data.

Our hypothetic analysis couldn't capture the economic drag from eventual monetary policy tightening. But we recognize that when the Fed does move, tighter monetary policy will no doubt shave off some of the economic gains currently reflected in this hypothetical analysis.

Breakdown Of The American Rescue Plan

Key elements of the ARP include direct payments of $1,400 per person, additional unemployment benefits, rent relief, food assistance, small business support, direct spending on a national vaccination program, aid to state and local governments, and education.

It also has provisions under which the federal government would send direct support to groups hit hard by the pandemic, including schools, families with children, small landlords, and essential workers.

Although the provisions in the stimulus package are very specific, we group them into the following four categories: direct payments to households, additional unemployment benefits, small business support, and aid to state and local governments (see chart 2).

More than half of the stimulus would go to households in various forms: the $1,400 checks, unemployment benefits, and various funding for targeted households and individuals. State and local governments would also receive 36% of the stimulus package--a relief to state and local governments with budgetary pressures, which received nothing from last December's bipartisan stimulus. Support for small businesses only takes up 8% of the package, but small business owners are still expecting more than $300 billion in financial aid from the December package. So, in general, important participants in the economy all received or are going to receive additional sizable support from the federal government, with the stimulus providing a bridge to the other side for many(3).

Chart 2


Overall, the ARP, if approved, would have the strongest impact on the economy this year, and demand-driven support would gradually dry up over the next two years (see chart 3). This happens in both the Biden proposal and in our baseline "$1 trillion" case, with the economy decelerating to trend by 2023 after a short-term bump.

The impact of the stimulus policies depends on the size of the federal aid and how quickly the money is spent (the marginal propensity to consume, or MPC). For illustrative purposes, we kept the model simple by using the CBO's recent MPC estimates for individuals, but with smaller adjustments for social distancing since we do not envision the country going back to the strictness of April (see "The multiplier impact by policy" section below).

Note, we used average CBO multipliers, a conservative approach. Under normal conditions, for every dollar spent, the economic activity generated would be under a dollar to varying degrees, with some policies closer to breakeven. However, it depends on where the U.S. economy is in the cycle. Fiscal multipliers are the largest when the economy is weak and the Fed keeps the policy rate at the zero lower bound (as has been the case for the U.S. in recent years with unemployment high, inflation low, and interest rates near zero). This suggests that our estimates using average fiscal multipliers for both the Biden plan and our base case have upside risk.

Chart 3


Long-Term Initiatives

The direct effects of such temporary fiscal measures (shocks) are generally limited to the duration of the measures themselves, with the persistence of the fiscal multipliers decaying in subsequent periods.

The Biden package being discussed in Congress may provide additional short-term relief needed to provide the bridge to recovery. But not all government spending is created equal, and these short-term policy fixes are by design temporary and don't pay for themselves. They will accelerate "filling the demand hole" but will not change the longer-run growth rate of the economy, which is a function of growth in productivity and the labor force.

Other fiscal policies, if chosen wisely, may be a better solution. Investments in physical infrastructure and human capital (public health and education), for example, are such long-term investments that they pay for themselves--and some more--and are urgently needed after decades-long underinvestment.

We know an infrastructure package is in the concept stages--so shovels won't hit the ground anytime soon. But the post-pandemic recovery is also likely to be slow, and many planned projects have stalled. Given that we currently expect the unemployment rate to be above full-employment levels until fourth-quarter 2023, those extra jobs coming sooner would likely be a welcome relief. Indeed, with interest rates expected to remain low for some time, the jobs market weak, and material prices low, now just may be the time to start.

Our Approach

When analyzing the impact of Biden's stimulus plan, we followed the same approach as in our previous report, "Economic Research: Bang For The Buck: How U.S. Fiscal Stimulus Could Benefit The Recovery." We grouped funding for direct COVID-19 containment efforts and specific groups hit hard by the pandemic under the following four policies: direct payments to individuals, additional unemployment benefits, small business support, and aid to state and local governments, assuming they would have similar multiplier effects as spending under these four policies, which we analyzed in detail in our previous report.

While it is unclear how large the Biden stimulus will be and when it will be absorbed into the economy (though the Democrat-led Congress plans to introduce the ARP bill as soon as this week), we assumed that the full $1.9 trillion proposal is approved and released later in the first quarter. We continue to assume a social distancing drag on spending activity and demand multipliers.

The multiplier impact by policy

In our multiplier analysis we rely on several CBO reports, as well as other outside analysis, including:

  • "The Effects of Pandemic-Related Legislation on Output." CBO.
  • Whalen, Reichling. Working Paper 2015-02, "The Fiscal Multiplier and Economic Policy Analysis in the United States." CBO.
  • Edelberg, Sheiner. "What could additional fiscal policy do for the economy in the next three years?" Brookings.
  • Seliski, Betz, et. al "Key Methods That CBO Used to Estimate the Effects of Pandemic-Related Legislation on Output." CBO.

In our analysis, direct payments to households--37% of the stimulus package--will likely be the strongest support to the economy in 2021, among the four broad categories of stimulus policies, because households tend to spend most of the money shortly after they receive the checks from the government. Still, households have slightly smaller MPCs from their one-time rebate checks, which make up a large chunk of these outlays, and the bulk of the effect is front-loaded due to their one-time nature.

Lower-income households have larger MPCs than higher-income households; thus, policies that benefit the lower-income group--such as unemployment benefits--generate the highest MPCs. Unemployment benefits, which make up about 19% of the total proposal, are also more persistent because they are distributed gradually by design. While the impact from direct payments will dwindle by 2022, unemployment benefits would keep supporting unemployed individuals and their families.

In 2020, tax rebates went out to households at a relatively generous income threshold level. For example, married couples filing jointly at an income threshold below $150,000 received the full amount. After that threshold, the stimulus checks became lower. Past the $198,000 threshold, a household would not get a paycheck--which lowered MPCs on average compared with the pool receiving unemployment benefits.

State and local governments were modeled according to historical experience because both the delivery of the aid and the speed with which it is spent are slower than for the other stimulus channels. Since state and local governments would receive 36% of the stimulus and they generally spend the money slowly, they would be the strongest support to the economy in 2022 and 2023.

Small businesses have the smallest impact because they receive only a small share of the stimulus package. Besides, the stimulus is likely to be used in balance-sheet repair to avoid shutdowns.


(1) "Biden to Unveil $1.9 Trillion COVID Response Plan," Committee for a Responsible Federal Budget,

(2) Okun's law describes the relationship between unemployment and GDP, where a 1 percentage point increase in unemployment over a year is correlated with almost 1.8% fall in GDP (the Okun coefficient), based on data spanning 1948-2019. The relationship between unemployment and gross national product (GNP) or GDP varies by country. Industrialized nations with labor markets that are less flexible than those of the U.S., such as France and Germany, usually have higher Okun coefficients.

(3) Some of the new policies in Biden's plan, such as funding for a new vaccination program and funding for childcare providers, may have additional economic benefits since they also work on the supply side of the economy, allowing people to safely work more.

This report does not constitute a rating action.

U.S. Chief Economist:Beth Ann Bovino, New York + 1 (212) 438 1652;
U.S. Senior Economist:Satyam Panday, New York + 1 (212) 438 6009;
Contributor:Shuyang Wu, Beijing

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