The Coming Economic Consequences of the $ 1.9 trillion US stimulus package

In March 2021, the world’s largest economic stimulus package EVER was passed in the USA. The American Rescue Plan Act of 2021 provides $1.9 trillion to stimulate the U.S. economy.

Shortly after, Joe Biden presented an eight-year infrastructure program worth two trillion dollars. Added to this are the economic stimulus packages already deployed in 2020. All these measures will help not only the USA but the entire global economy. But they also entail risks for global economic development.

U.S. stimulus package boosts U.S. economy

The Spring 2021 economic stimulus packages include numerous measures. Included is a one-time payment of $1,400 for many citizens, an increase in unemployment benefits, higher education spending, financial aid for businesses and agriculture, investment spending for roads, bridges, energy and water supply, research and development for future technologies.

All these measures increase demand for consumer and capital goods in the U.S. Companies are adapting to this demand by increasing production and employment. The resulting labor income causes a further increase in consumer demand.

As a result, the International Monetary Fund (IMF) estimates in its economic outlook published in April 2021 that U.S. real gross domestic product (GDP) will grow by more than six percent in 2021. This is the strongest growth rate since 1984.

U.S. stimulus package strengthens growth in the rest of the world

The high demand for goods and services in the U.S. is also benefiting the U.S.’s trading partners. They can sell more products in the U.S., stabilizing production and employment in their own countries.

German foreign trade is a good example of this: The U.S. remains the most important buyer of German exports. Therefore, the German Macroeconomic Policy Institute (IMK) expects German real GDP to receive an additional 0.3 percent growth boost in 2021 because of the American Rescue Plan Act of 2021.

Stimulus program increases U.S. current account deficit

Boosting demand for goods in the U.S. increases American output and employment. However, with such a sharp increase in demand, domestic companies cannot produce all the goods needed. The U.S. is therefore dependent on products from the rest of the world, as mentioned above. This means that the U.S.will import more than it exports. According to IMF estimates, the U.S. current account will reach a record deficit of around $875 billion in 2021.

When a country spends more than it earns in foreign trade, it must borrow abroad for the resulting shortfall. The U.S.’s foreign debt is, of course, now growing. Public debt is also increasing.

Economic stimulus packages drive up public debt

The economic crisis triggered by the corona pandemic is hitting public budgets twice. The temporary economic slump led to declines in tax revenues. The stimulus packages mean higher government spending. When falling revenues meet rising spending, the result is a public budget deficit.

For 2020 and 2021, the IMF projects government financing deficits in the U.S. of more than 15 percent of the GDP in each year. These are the highest deficits since the Second World War — and larger than in the financial and economic crisis of 2008/2009.

As a result, the level of public sector debt is also growing. For 2021 and 2022, the IMF expects public debt to be equivalent to around 132 percent of U.S. GDP — also record levels. Economic risks could arise from this high level of debt.

Is there a threat of rising interest rates?

Increasing debts of a company or a government usually lead to a decline in confidence in creditworthiness. As a result, lenders demand a risk premium for further loans. Interest payments become larger.

In fact, we see a rise in long-term yields in the U.S., i.e. yields on bonds with a ten-year maturity: With the economic slump in the spring of 2020, the U.S. Federal Reserve made a massive cut in key interest rates. As a result, long-term bond yields also fell from 1.5 percent in February 2020 to 0.66 percent in April and May 2020.

Since then, yields have been rising again, although the Fed’s monetary policy has not changed. In March, they were 1.6 percent, above the February 2020 level.

Rising interest rates in the U.S. can stall the global economic recovery through three key channels:

What are central banks doing?

Whether interest rates actually rise worldwide depends to a large extent on monetary policy. As long as central banks continue to buy securities on a large scale to pump liquidity into the markets, strong interest rate increases can be prevented.

Interest rate hikes can only be expected if inflation rates rise sharply. In fact, inflation rates have been rising since the beginning of 2021, especially in the U.S. However, it is not yet possible to predict how monetary policy will react to this.

Since the central banks know that interest rate hikes could halt the economic recovery, I do not think they will seek any noticeable interest rate increases in the near future. For the time being, I assume that the U.S. economic stimulus packages will stabilize the global economy.

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